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V 1 

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Commercial 
Paper 



A Text Book for Merchants, 
Bankers and Investors 



By 

Roger W. Babson 

and 

Ralph May 



Published by 
Babson's Statistical Organization 

•rporated I 

i. i cutive < >iiicr~ : Welleslej Hilla 
Massachusetts 

Largest organization of Us kind In the 
United Statet 






Copyright 19ll 

by 
Roger W. Babson 



©CLA30382I 

NO. I 



69 9 



TABLE OF, CONTENTS. 

Preface 5 

CHAPTER I. 
L> nding and Borrowing 7 

(IIAPTER II. 
The Form of Commercial Paper 31 

CHAPTER III. 
The Selection of Commercial Paper 82 

CHAPTER IV. 

The Analysis of a Financial Statement 

and Report 110 

(IIAPTER V. 
Blinking 1 }:; 

CHAPTEE VI. 
I In Rediscounting of Commercial l } <ij><r L95 

CHAPTEE VII. 
How Interest Rates May be Forecasted . . 226 



PREFACE 

MAW parts of our financial system of the 
United States arc now arousing more 
discussion as to their adaptability for 
our great needs than they have for years. It is 
to point out the condition, the tendencies and the 
importance of one great factor in this system. 
Commercial Paper, its strength and its defect-, 
that the following pages are written. 

The book is primarily written for the officers 
of our nation's twenty thousand hanks, to aid them 
in selecting the best of such paper; but all mer- 
chants and manufacturers who borrow money, 1 
believe, also will find this hook very helpful. 

I especially wish Here to state that practically 
all the work of preparing this book has been done 
by my associate, Mi-. Ralph May, who, in addition 
t<> knowing the theory involved, is connected with 
one of the largest commercial paper firms in 
Boston and thoroughly understands the practical 
Bide of the Commercial Paper business. There- 
fore T«» Mi*. May belongs the credit of this work, 
my name appearing firsl -imply owing to bis 
courtesy to me. 

Roger \Y. Babson. 

Wellesley Sills, Mass. 



CHAPTER I 

LENDING AND BORROWING. 

THE money in a community is enhanced 
to the holders if it can be made to in- 
crease. In any community with a proper 
monetary system, money and the substitutes for 
it which are broadly classed as money, practically 
correspond to the wealth or well being of the com- 
munity. If we take money as representing the 
wealth <>f a district, which is not strictly a true 
representation, as we shall see, but which is suf- 
ficiently so tV>r our purpose; and capital, as that 
part of the money used in the attempt to increase 
any given supply of money, Ave have the basis of 
business, and the first factors to notice in an in- 
stigation into what constitutes an effective sys- 
tem for the increasing of any given supply of 
alth. Most men have a desire to progress in 
whatever they have undertaken. A- most of us 
are dependent for our happiness to a huge extent 
<>n money, most of us are engaged in turning our 
money into as effective a form of capital as is 
3sible. Provided gain in money to the holders 
[ginal capita] is not at the cost of the good 
die whole community, thia advance is ant- 

ly to he attempted and rvcry method for giving 
individual ho! money opportunity to turn 

it ita] i- to 1>" discovered ami 



8 COMMERCIAL PAPER 

Money is Unevenly Distributed. 

In every community money is unevenly distrib- 
uted among the individual holders. Some men 
are born rich, some acquire riches and some have 
riches thrust upon them. The shrewdness, ability, 
or opportunity of some over others have always 
caused a difference in the distribution of money. 
With this in mind it is easy to see how certain 
men are better able than others to make money 
earn more money. It is also easy to perceive that 
oftentimes it is not the men with opportunity who 
have the money to turn into capitalistic form. 

Interest is Divided Between Borrowers 
and Lenders. 

If it is well to attempt to turn to capital account 
any given supply of money in a community or 
nation, any thing or things which can bring this 
about are needed servants of the community. 
Lending and borrowing, if according to true eco- 
nomic principles, are such, and their use is to be 
aided by all possible means. Lending and bor- 
rowing serve a double economic purpose. Lend- 
ing, if the lender has not as satisfactory a chance 
to increase his money as capital as the borrower 
has, insures to him an enhanced value of his 
money. Borrowing, if the borrowing is war- 
ranted, insures to the borrower a certain amount of 
money wealth. Interest is something like eco- 
nomic rent. No money will be lent which the 



I 



LENDING AND BORROWING 9 

lender feels will not show an actual compensation 
in return for the time and ability spenl over look- 
ing up the security of a loan, plus the amount 
the lender could make his capital return if he 

■hied it himself. On the other hand, no bor- 
rower will borrow unless he feels that his borrow- 
ing will bring him a return sufficient to compensate 
him for the time and ability he spends in wielding 
the capital lent him. The return in borrowed 
capita] over and above the sum equivalent to these 
two compensations we may call middle ground 
interest. Properly, the borrower and the lender 
should each receive one-half of any middle ground 
interest there may be, but the actual apportioning 
of this part of the gain on capital is ruled by the 
relation or apparent positions of lender and bor- 
rower. 

Commercial Loans Carry Pure 
Interest Only. 

The price of money, at any one time, like the 
price of anything else, is ruled by demand and 
supply. Therefore, if a single borrower is oppos< d 
by several lenders, his -bare in the middle ground 
interest is properly more than one-half, and vice 
versa. Bui fused into this is the knowledge of 
the lender of the borrower's desire to borrow, or 
the borrower of the lender's desire to lend. 
Fused into this also is what the borrower can make 
the lender think his need to lend is, or," on the 
oibcr hand, what the lender can make the borrower 



10 COMMERCIAL PAPER 

think his need to borrow is. Actually, the appor- 
tioning of any middle ground interest is dependent 
on what appears to be the demand and the supply 
rather than what really is the demand for and the 
supply of money. We are speaking now of ordi- 
nary business loans in which no more than on ordi- 
nary business risk is involved. The interest in 
such loans, may be called pure interest, whether it 
takes the form of discount in commercial paper or 
interest in collateral loans, bonds or other form of 
investment. When there is an evident element of 
risk in a loan over and above that always apparent 
in business loans, the apportioning of middle 
ground interest is directly dependent on the risk 
involved; for such interest takes the form of a 
bet or insurance. 

Insurance of Commercial Loans 
Should be Possible. 

Insurance companies have served a very useful 
purpose for the world in accepting individual risks 
because of the strength of many. Health, the 
value of real estate and of shipping have all been 
allowed to retain constant values through insur- 
ance. As yet such chance for the retention of the 
face values of commercial loans of money has not 
been afforded to any marked degree by insurance 
companies or other financial agents, and in such 
loans there is a great field which must surely soon 
be opened. Doubtless within a comparatively few 
years an enormous amount of insurance will be 



LENDING WD BORROWING 11 

taken in one form or another on loans bearing 
unusual risk. There is no more reason why loans 
for ventures of unusual risk should not be insured 
than that destructablereal estate or shipping and 
the like, which would be largely the product of 
these l<»an-. should be insured. Up to a certain 
point, very considerably beyond that now admit- 
ted, borrowers should be able to get credit, and 
this they undoubtedly will be able to receive 
before long. At the present time the only method 
<>f writing such insurance or semi-insurance is 
through lenders which are largely banks or other 
forms of fiduciary agents. It is obviously the 
duty <»f Mich lenders to avoid unnecessary risks 
and to confine themselves as much as is possible 
to the gaining of interest in pure form. Kisks, 
however, must sometimes be taken. As President 
lladley of Yale says: ".Risk is an incident to 
progress." We should hardly be far advanced in 
our increase of wealth if we had avoided Risk 
altogether. Some method of insuring risks in 
lending should come to the front; but it should 
be distinct from the methods of raising money lor 
ordinary business loans. Any student of the in- 
crease of money wealth or of any of its factors 
must studiously avoid confusing the interest de- 
pendent on ordinary business transactions in which 
there is no reason to suppose there is more risk 
involved than i in the average business trans 

action and those transactions in which there is 
admittedly more risk. 



12 COMMERCIAL PAPER 

All Lenders Should Study Business 
Conditions. 

It is, of course, apparent that knowledge of 
conditions is the great factor in the deciding to 
which class loans belong. What may be pure in- 
terest to one man may be interest in the shape of 
insurance or a gamble to others. For this reason 
it is most important that all lenders should be as 
thoroughly conversant with the fundamental condi- 
tion of the nation as a whole as well as with the 
conditions of borrowers. With bankers too much 
stress cannot be laid on their acquaintance with 
general business conditions, the basic factors in 
their business world and the general forecast of 
future business events. To gain the right to 
compete with the ignorant and to enter a small 
group from a large one, often enables a lender to 
secure from the law of demand and supply what 
is pure interest at a considerable advance over the 
average of pure interest return in that particular 
market. Where lending is a business in itself 
nothing but constant study of the many changing 
business conditions will enable the lender to com- 
pete at such advantage with his fellows. It is 
most advisable that every aid in this direction 
shall be made use of. 

Loans are to be Classified. 

In dealing with the particular subject under- 
taken, we have to consider primarily those lend- 



LENDING AXD BORROWING 13 

ings and borrowings in which there is no more 
than an ordinary risk. Commercial paper, as we 
shall Bee, is by its very nature opposed to any 
usage except for ordinary mercantile transactions 
in which no more than the average risk in such 
dealings is involved and in which any interest ac- 
qruing is interest in pure form. There are various 
forms of borrowing, both for loans involving ex- 
ceptional risk and for those which do not; but as 
interest in the form of insurance is a study by 
itself and without our especial field we must here 
(•online ourselves to the ordinary business loans 
or those in which money seeks to turn itself into 
capital and at the same time to avoid channels 
in which its gain may not readily be classed as 
pure interest. Loans dependent on such capital 
may he divided into the following classes: — 

1. The borrowing directly from one thoroughly 
conversant with the condition of the borrower. 

(a) Loans between individuals, with or with- 
out security, in which the lender has an intimate 
acquaintance with the borrower. 

Loans between groups of individuals or 
between a borrower and a bank where the lenders 
have such intimate knowledge. 

_. The borrowing through one or moye distanl 
channels from lenders only moderately conversant 
with the condition of the borrower. 

Lou- time loans, with or without security. 

(b) Slort time loans, with or without security. 



14 COMMERCIAL PAPER 

These classifications may, of course, be them- 
selves many times subdivided ; but for a short in- 
quiry into lending and borrowing and for our 
especial purpose they will suffice. 

Classes 1 and 2. 

In Class 1, that of loans in which there should 
be protection through knowledge against any ex- 
ceptional element of risk, we have to place broadly 
such loans as the careful investor would at once 
feel fairly certain of as being paid at maturity. 
~No one can be sure of absolute security in the 
world of lending and borrowing; but there are 
many loans, some apparently better than others 
because of known resources back of them, yet all 
of which seem from the first likely to be convert- 
ible into cash at their expiration. These are to 
be grouped under Class 1. To Class 2 belong such 
forms of loans as those which, because of lack of 
knowledge of conditions or for other reasons, need 
and receive additional "checks" or security to prove 
their soundness over and above the safeguards 
which a lender having intimate knowledge of the 
borrower would demand. 

The Place of Commercial Paper. 

Commercial paper, which is our subject, is a 
form of loan, with or without security, suited only 
for a short time transaction in ordinary mercantile 
business, and always' provided that the laws re- 
lating to the issuance of commercial paper are 



LENDING AND BORROWING 15 

kept, this, or any form of loan at all closely allied 
to it, finds its place distinctly in Class 1 or 2 of 
our classification of loans. It will appear that 
if any commercial paper ever by its history proves 
itself to have belonged or to belong outside of the 
employment of capital in which the accruing in- 
terest cannot be classed as pure interest, it is be- 
cause the laws governing its issuance have been 
disregarded. Loans to packing houses on short 
time, or to some large dry goods house or to a mill 
(if properly issued,) are examples of commercial 
paper. These loans are made to firms conducting 
a well known business and for well known needs. 
They distinctly belong with loans the interest on 
which is pure interest, as there is no exceptional 
risk involved in the loan. Stock subscriptions, 
underwritings and loans for unusual commercial 
I-' n if for a short time only, cannot be 
dj and belong to a field outside our 
slated divisions. 

Collateral Loans. 

In our first division of loans, that is, of loans 
in which there appears to be no especial element 
of risk and in which the lender lias an intimate 
acquaintance with the condition of the borrower. 
have to deal first with leans which show their 
value in their form, such as lean- secured by 
salable collateral, and second with unsecured Loans 

3Uch ;.- Usually OCCUr between banks and their in- 
dividual customers. There are other lean- which 



16 COMMERCIAL PAPER 

fall into this class but the foregoing are the most 
prominent. Collateral loans form a very consider- 
able portion of bank investments throughout the 
world and are among the safest. In this country 
loans on approved collateral with a ready salable 
value and a margin are considered as among the 
most desirable investments to be had. Even the 
necessity for allowing borrowers against collateral 
to make exchanges against this collateral does not 
change their relative position as compared with 
unsecured loans. Abroad, commercial bills, if in 
acceptable form, bring lower rates than collateral 
loans do ; but abroad, commercial paper is on a 
different basis from what it is with us. Collateral 
loans to be worthy of the name must be secured 
by collateral for which a market is known and the 
collateral should be put in at prices which can be 
readily obtained in that market. Securities quoted 
daily on some large stock exchange, and generally 
accepted as being quoted at a fairly constant valua- 
tion, should be the most acceptable form of col- 
lateral. 

A Margin Should be Guaranteed on 
Collateral Loans. 

A margin in value of collateral over the face 
value of the note should be given, the amount of 
margin varying with the chance for sudden shrink- 
age in the salable value of the collateral. A 
guarantee should be given in the note that this 
margin will be maintained during the life of the 



I 



LENDING AND BORROWING 17 

loan or the loan will become due and payable. In 
the case of the besl bonds ten per cent is usually 
taken as a conservative margin to be required to be 
maintained when active, listed bonds are given as 
collateral against borrowings. In the case of the 
best active listed stocks twenty per cent is cus- 
tomarily demanded as a conservative margin. On 
stocks other than the best or in the case of loans 
jured by stocks which are all of one kind or 
very similar, a grekter margin than twenty per 
cent is often required to be maintained, here again 
the margin being dependent on the history of the 
prices at which the stock has sold and the chance 
for its depreciation at the moment. Loans se- 
cured by one class of stock or bonds are obviously 
not as satisfactory as loans secured by mixed col- 
lateral. 

Collateral Loans Form Our Best Test 
of the Money Market. 

Collateral loans with us test the value of money 
for the moment better than any other form of 

lurity. Call loans, which banks put out from 
day to day and which they depend on first to re- 
plenish their reserves if a need comes, all arc 
secured by quick, usually the quickest, collateral. 
Call money, as it ia known, and money lent or 
three or four month- time againsl the same Borl 

collateral, which, by the way, is usually sixty- 
five per cenl railroad stocks and thirty-five per 
* industrial stocks, arc as uear money as any 



18 COMMERCIAL PAPER 

loans can well be. Interest or discount accruing 
on these loans is absolutely pure interest and 
represents without any foreign factors exactly what 
money is worth for the time the loan is made. 
From call loans secured by stock exchange col- 
lateral, sixty-five per cent railroad, thirty-five per 
cent industrial, and properly margined or secured 
by similar collateral that has an immediate salable 
value, it is but a step to loans secured by like col- 
lateral for six months, a year, or even longer. 
The longer loans are of the same order as the 
shorter ones though they make use of money held 
for rather different purposes than the money which 
goes into short time collateral loans. The good- 
ness of the longer time collateral loans is, too, 
somewhat more difficult to estimate than is that 
of the short ones, for it is hard to foresee just 
what level of prices for securities will rule from 
six to twelve or more months ahead. The margin 
requirement partially obviates this difficulty so far 
as the security for the loan is concerned ; but the 
late maturity prevents the lender from using the 
money for the purchase of securities if prices 
decline greatly before the loan matures. 

Weaker Collateral Loans Should be 
Especially Well Margined. 

Often certain notes creep in among collateral 
loans on which the collateral, though apparently 
in good repute and fairly salable, is dependent on 
the efficiency of the promisor for its salable value. 



LENDING AND BORROWING ID 

Borrowings by bond and stock houses carrying 
large blocks of securities which obviously require 

very extensive work to sell, which have not a broad 
market and which are offered chiefly by the bond 
or stock house in question are examples of such 

loans. These loans, though not necessarily faulty, 
should be protected to a fuller extent than the 

other collateral loans already referred to. If such 
notes are taken, the promisor should be known to 
have especial strength and a considerably larger 
margin than on loans secured by more salable col- 
lateral should be called for. Twenty to thirty 
per cent is not too much to ask for on notes secured 
by bonds carried in this way, and thirty to fifty per 
cent on stock. Moreover, great care should be taken 
that the securities given as collateral are put in 
at what is really a fair valuation. Too often the 
collateral is valued at the "asking price" instead 
of ar the "bid price." 

The Best Collateral is Listed Collateral. 

I he fact that a security is listed on a stock 
exchange, even the New York Stock Exchange, is 
DOt in itself evidence to wan-ant its being accepted 
as the bgst of collateral, any more than the fact 
that a security is no1 listed should preclude it 
from acceptance as collateral. The best collat- 
or, is that listed <>n some large stock 
exchange, because it can he more readily quoted 
there than in the private market ; and, to he satis- 
factory, collateral must no1 only he listed, but 



20 COMMERCIAL PAPER 

quoted and quoted regularly through bona fide 
sales and purchases, at least several a day. The 
amount of such sales and purchases over some 
time should also be taken into consideration in 
lending against the security in question. 

The Relation Between Banks and Their 
Customers Should be Very Close. 

In the case of unsecured loans between banks, 
individuals or groups of individuals and their 
customers for money, a more difficult problem 
presents itself than that which appears in loans 
secured by collateral. Banks doing a general bank- 
ing business largely cater to those persons engaged 
in business who will keep a fairly large deposit all 
the time with a bank for the sake of being able 
to call on the bank for a loan, usually consider- 
ably larger than the deposit, at certain times 
during the year, the amount to be loaned and the 
length and other terms of the loan to be governed 
by the amount of the deposit and the condition 
of the bank. Such so-called "borrowing accounts" 
form the basis of the deposits in most of our na- 
tional banks and in many of our trust companies 
and state banks in this country. Loans based on 
them fall distinctly in the class of borrowing in 
which there is or should be a most thorough per- 
sonal knowledge of the condition of the borrower 
on the part of the lender. Borrowing accounts 
with banks exist either to effect the major part of 



LK\niX(i AND BORROWING 21 

the financing of a business or to effect a final and 
absolute resource in time of need. It is obvious 

that in either case the bank should know exactly 
where it stands in regard to its customer, a knowl- 
edge which necessarily includes thorough informa- 
tion in regard to the business done and the busi- 
ness needs of the customer. As safety of its own 
deposits should be primarily its first care; a hank 
cannot for a moment afford to offer itself to till 
a wide breach, such as a borrowing account often 
offers, unless it knows that it stands on firm 
ground. A nig depositor using his deposit as a 
borrowing account should recognize this fuel ab- 
solutely ^ and should regard his loans with the bank 
as that with his best friendj being trilling to show 
his condition at all times and also being willing to 
he guided so fur as his financing is concerned 
largely by his bank's ad rice. The financial ex- 
perience of the officers of a bank is necessarily so 
much wider than that of men engaged in mercan- 
tile affairs alone that if the bank officers are stu- 
dents of fundamental business conditions their 
advice should be taken as the best obtainable. 
Respect, too, should ho shown a bank by a customer 
in the case of a friend if the demands on the 
hank appeal- to he such as to preclude a loan as 
asked t'<»r mi account of other demands OD the 
bank'- resources. Such occurrences as this where 
a h»an i- asked for in all fairness should not occur 
often. If it due- other borrowing accounts should 
he opened in other banks; hut occasionally such a 



22 COMMERCIAL PAPER 

condition will arise and when it does the bank 
deserves friendly consideration. 

Banks Should Not Pay Interest on 
Borrowing Accounts. 

Two facts are very important in a consideration 
of borrowing accounts. The first is that a borrow- 
ing account should not give a customer of a bank 
a right to demand a loan larger than four or five 
times the amount of his average deposit, a loan 
which should not be for more than ten months of 
the year ; and which at least once each year should 
be paid in full. The second is that banks having 
borrowing accounts should not pay interest on 
those deposits made by borrowers which call on 
the bank to any considerable extent for loans. 
There is too much competition between banks on 
a basis of a war of interest. Such a struggle is 
injurious to the best interests of banking and to 
the usefulness of banks to their customers, as it 
hampers them greatly. For borrowing accounts 
banks perform enough service as it is, and this 
should be sufficient. 

Large Borrowers Need Resources Other 
Than Their Own Banks. 

Bank accounts carrying the right to borrow at 
the bank, at certain times, or so called borrowing 
accounts, include the right to the depositor to 
call on the bank to protect short overdrafts, or to 



i 



LENDING AND BORROWING 23 

discount short or longer time notes or commer- 
cial paper. The chief use of such accounts is, 
however, limited to the righl of the depositor to 
the discounting of shorj time loans or commercial 
paper. .It is this that tonus the basis of the lend- 
ing to customers on the pari of mercantile banks, 
a lending which, as has been shown, should be 
dependent on an intimate acquaintance between 
borrower and lender. As will be readily seen, 
however, no man or group of men engaged in ex- 
tensive business operations can fairly expect to 
obtain, or as a matter of fact can by law obtain, 
all the money they need to borrow for their business 
from their bank or banks. Such men, too, like to 
keep their opportunities to borrow from their own 
banks open so that in case of need they may fall 
hark on them. The consideration of the borrow- 
ings that these men make use of, therefore, leads 
us to the consideration of Division i ; in our classi- 
fication of loans — those loans made through one 
or more distant channels and from lenders who 
<-an ho only moderately conversanl personally with 
the condition of the borrower. Such loans arc 
from the point of view of the borrower, hardly dif- 
M the loans made with friends or with 
hi- own hank-. To lenders under this class, how- 
ir, the difference is very great. A general 
knowledge of the condition.- of the borrower is 
impossible, with the resull that either certain spe- 
feguard jailed for to surround 

loans of this class or i1 must be stipulated that 



24 COMMERCIAL PAPER 

loans shall take a certain form, the safety of which 
is fairly apparent. 

Many Large Borrowers Can Best Finance 

Themselves Through Well Secured 

Bonds. 

Many businesses need to borrow money for a 
long period. Such businesses do not care to tie 
up their ability to borrow from their own banks 
or friends for good and all, so they make use of 
the general investing public or the general invest- 
ing banks. This is done primarily through the 
medium of bonds, and customarily these bonds are 
secured by mortgage. There are a great many 
people with available wealth wishing to turn it 
into capital without accepting much risk them- 
selves, and who cannot or do not care to place their 
funds in local loans. To such the offers to borrow 
on the part of large businesses, the good standing of 
which is generally accepted, offers which come for 
small sums and all of which are secured by a share 
in fixed assets, the stability of which is vouched 
for, form attractive inducements to many to turn 
this available wealth of theirs into capital. To 
the borrower such forms of loans are little less 
advantageous than ordinary notes. They must be 
paid just the same; and whether the fixed assets 
are mortgaged or not does not affect the general 
business clone. To the lender, however, there is 
certain knowledge that there is something to fall 
back on in case the earnings of the company fail. 



LENDING AND BORROWING 

To those who lend this makes all the difference 
in the world. Lenders believe, of course, in the 
g neral successful operations of the company, luit 
really base their loan on fundamental assets. For 
this - o borrowers who make use of distant 
capital, which ran be only moderately 
aversant with the actual condition of the bor- 
rower, should not fail to appreciate the point of 
view of such lenders and be ready to secure their 
bonds in every reasonable way. They will have 
far better success in their borrowings it they do 
this. 

Long Time Bonds Should be Especially 
Well Secured 

L riders of this -tamp should demand ample 
margin of safety in security on long term Loans. 
Conditions chj og 30 rapidly, 1 S] 1 eially in a new 
country like this, that the longer a loan is made 
for the better should the loan be protected. That 
the country is constantly advancing in inherent 

alth and that a business now successful should 
_ >w with it. i> imt a sufficient answer to this 

tement. Very long term bonds, say for any- 
thing <»vcr twenty-five years, should be especially 
well protected, and if possible some method for 
partially, at least, repaying the total borrowi 
should he introduced into the tonus of the bond 
Sinking Is [lent insl itutions 

the lender, and rarely hinder the operations of 
the borrower. The Bale of refunding is a 



26 COMMERCIAL PAPER 

perfectly proper means of raising money on the 
part of a borrower to repay loans, but a possible 
lender sometimes questions how much refunding 
a borrower may be able to do fifty or a hundred 
years from the time the loan is made. The in- 
troduction of sinking fund requirements in the 
terms under which long time bonds are issued, will 
aid the selling of those bonds enormously. An 
even better scheme of finance over sinking fund 
requirements is to have an issue of bonds mature 
serially. This over a term of years tvorks better 
for both borrower and lender. 

Debenture Bonds May Also be 
Satisfactory. 

Some large borrowers in excellent standing may, 
after covering their fixed assets with mortgages, 
still wish more money and issue debenture or non- 
mortgage bonds. These may or may not be good ; 
but investment in them should not be made till 
after a very careful study of the earnings, assets 
and general reputation of the borrower has been 
made. Debenture bonds such as those of the 
Boston and Albany Railroad Company, which has 
no mortgage on its property, are, of course, as long 
as the bonded debt is considerably less than the 
fixed assets of the company, just as good in them- 
selves as mortgage bonds ; but it should be remem- 
bered that mortgages may be placed on such 
property unless a promise has been given in the 
debentures that they shall not be so placed. Such 



LENDING AND BORROWING 27 

bonds, therefore, are not as satisfactory as mort- 
gage bonds, though in the case of debenture borrow- 
ings, such :i> those of the Boston and Albany, 
Lenders may expect that a history of good standing 
as to credit will be maintained, and thai even if 
a mortgage were executed it would hardly be so 
placed as to imperil the holders of debenture bonds. 

Short Term Notes are Also Often Proper 

Mediums of Finance. 

What is true of long term borrowings through 
distant sources, is Largely true of borrowings for 
shorter time. A belief in the convertibility of 
the l<>au and its actual convertibility must be 
present if a loan is worthy of the name. Often 
a company can issue bonds but does nol wish t<> 
-ell them at the moment, cither because of an 
inappropriate money market or for other sound 
reasons. A company often in such an instance 
issues the bonds and instead of selling them pla< 
them a- security, usually with a margin, against 
six months, one, two, three, or more year no1 
Such borrowings usually are of considerable value 

the borrower, who in consequence pays a rate 

interest which is always attractive on the money 
market in which they arise. If the terms are 

isfactory, these Loans should be very attractive 

3, a- it keeps their capital fairly Liquid 

and ready t<» take advantage of opportunities i"<»r 

ional investment, a- they occur. Stock of 

controlled, or partially controlled companies, is 



28 COMMERCIAL PAPER 

occasionally placed as collateral on such notes 
instead of or with bonds. The value of such col- 
lateral is dependent on the worth of the companies 
represented by the stock and although stock is not 
as a rule as desirable for security as bonds, loans 
like these, secured by stock in part or whole, as, 
for example, certain notes of the "Bell" Telephone 
Companies, may be very good investments. 

Short Term Railroad Debenture Notes 
May Also be Satisfactory. 

Many railroads, when the investment market 
is not to their liking, issue short term debenture 
notes. Though business conditions change rapidly, 
they can hardly change so much that steam rail- 
roads in good standing can in a few years fail to 
protect such debenture notes. Railroads have wide 
credit, if they have it at all, and are consequently 
better able to issue and to protect debenture notes 
with safety to the lenders than are industrial 
corporations serving a local district, and apt to 
keep their business as secret as possible. Deben- 
ture borrowing of railroads and like corporations 
on comparatively short time are a satisfactory form 
of finance provided the borrower is in good stand- 
ing and has wide credit, not otherwise. 

Commercial Paper is a Medium of Finance 
For the Purchase of Merchandise Only. 

General businesses need to borrow money for 
short periods of time to a considerably larger 



LENDING AND BORROWING 2S 

extent than public service corporations, They find 
a call for merchandise and a chance to buy it for 
less than they can sell it. To till all orders they 
can get they need more money than they have with 
which to buy this merchandise. Such borrowing 
as this, to buy merchandise or something similar 
which is to be turned into cash, presumably at a 
profit, and within a short time, is called borrowing 
through commercial paper. Commercial paper is 
the name given the medium for such borrowing 
and is not properly applied to any other form of 
(borrowing. Tt rills a field of its own and requires 
separate analysis and study. It is different from 
the borrowing of railroads and public service 
corporations, even for an equivalent time. It is 
different from the borrowing of an individual on 
the most salable of security and with ample 
margin. It i- a method of finance all its own, 
just a- mortgage l><>nd< are in their particular 
tield. It is a very important factor in the finan- 
cial system of any country, for as business is the 
attempt to turn available wealth into capital and 
;i- most business must have to do with the purchi 
and -ale of merchandise, so commercial paper must 
play a most important part, if not the mosl impor- 
tant part, in financing the business needs of ;i 
community or nation. Commercial paper is one 
the biggest aid- that we can make use of in 
tiomic progress, that i-. in the acquisition of 
true wealth. Commercial paper i- entirely ae 
proper an economic medium for borrowing and 



30 COMMERCIAL PAPER 

lending in its own particular field as are other 
forms of security in theirs, and when properly used 
to do the work for which it is intended, and no 
more, it is exactly as safe. In fact, for the student 
of fundamental conditions, who at times needs to 
have his money in liquid form awaiting a forced 
readjustment or panic, good commercial paper is 
often the very best investment procurable. 

We Have to Deal Here Chiefly With 
Commercial Paper. 

The purpose of this treatise is to deal chiefly 
with Commercial Paper, its different aspects, its 
purpose, and what should be its required form to 
make it an available agent for its needs. We have 
already seen that it appears among the borrowing 
from lenders thoroughly conversant with the condi- 
tion of the borrower. It necessarily plays a larger 
part in the borrowings from the many at a distance 
who cannot well be so conversant. It is chiefly 
as a medium for such borrowings that it is to be 
considered, but its similarity is great in both 
instances, and its function and form in both cases 
can be considered as the same and studied together. 



CHAPTEB II 

THK FORM OF COMMERCIAL PAPEB 

THE first axiom in the borrowing of money 
by note or bond, where risk is not ad- 
mitted, i> that borrowers shall prepare in 
their borrowing for payment of the loan at matu- 
rity. A borrower who cannot meet his obligations 
is not the sort of borrower lenders wish to meet, 
and even if his assets are sufficient to pay his 
debts, their liquidation takes time and causes 
trouble and expense for the lender. A note which 
is paid after it is due is not wholly had: but it 
is not in accordance with good business and it is 
not the sort desired by lenders, especially bankers 
who specialize in lending and have to figure 
m- - v en each of their investment-. Any 

- dy of loans which will show such lenders how 
to avoid taking loans which will not he paid till 
they arc overdue will he rated nearly as high 
- that which will tell them how to avoid worth- 
ai-worthless investments. NTotes which 
have to be extended for a considerable time are 
t«> he classed with m>te< which are paid a com- 
paratively short while after they mature, for it 
die chai _ ' _ on the part of busy 

men which non-payment of obligations at maturity 

is the principal disadvant; 
such obligations carrywith them. 



32 COMMERCIAL PAPER 

Refunding of Commercial Paper May 
or May Not be Permissable. 

It follows, as we have partially seen, that those 
who borrow through commercial paper as a 
medium of finance should use the amount of 
money borrowed in those interests only which will 
presumably arrive at maturity within the life of 
the notes i^iven for the amount in question. A 
firm borrowing $200,000 or $2,000,000 to buy 
merchandise by an issue of mercantile bills, notes 
or commercial paper — the terms are synonymous 
—which is able to sell only $175,000 or $1,750,000 
worth of merchandise within the life of the notes 
and yet which is able easily to discount another 
issue of notes before the first lot are due, is in a 
safe position; but, the (inn is good really not 
because it can do this but because its credit is 
acknowledged, because lenders are sure that if 
forced it could liquidate its unsold merchandise. 
Refunding of commercial paper is common enough, 
just as refunding is in the case of bonds, for busi- 
ness operations often take longer than the expected 
time and because it would often injure general 
business, as lenders recognize, to force a firm to 
clean up an issue of commercial paper before the 
merchandise into which the proceeds of this paper 
have gone has been properly placed. But such 
refunding should never be at the expense of the 
original lenders. If such lenders wish their 
money at the expiration of their notes, the money 



THE FORM OF COMMERCIAL FAPER 33 

should be forthcoming. If the borrowers have not 
sold over $175,000 or $1,750,000 of their mer- 
chandise and can sell more notes for $25,000 or 
25,000 to lenders who really want them, well 
and good ; but if they cannot, they should liquidate 
even at a loss and make up the loss from other 
sources. 

If a Lender on Commercial Paper Wants 

his Money at Maturity He Should 

Always Get It, 

By every moral and economic law, apart from 
legal regulations, the forcing of renewals on 
holders of commercial paper, even in part, is 
wrong and disgraceful. Such renewals are being 
forced on many lenders today. In the Panic of 
1907, they were of common occurrence, although 
forced renewals of commercial paper then occurred 
not wholly because of the faulty method of use 
of the proceeds from the paper, but largely for 
deeper, though no less disgraceful reasons. The 
Panic of 1907 brought to light, however, as do 
the forced renewals of paper in normal times to 
a less degree, the weak understanding of the use 
of commercial paper as a medium in finance or an 
utter disregard for its precepts. Finance is very 
much like medicine. There are certain funda- 
mental laws of health in finance which musl be 
recognized and regarded and any disregard of 
them should be frowned on, as is the man who 
dlessly ruins his health or the health of others, 



34 COMMERCIAL PAPER 

Healthy conduct in finance is, however, far more 
important than it is in the care of one's body, 
for in finance any disregard of the laws of health 
injures not oneself so much as others. The bor- 
rower who makes use of commercial paper as a 
medium of finance and who goes beyond its scope 
and does not reasonably protect it, is a criminal 
at economic if not at common or statutory law, 
and should be so decried. In this country we have 
so much work to do and there is so great a chance 
for profit that we have become lax in our regard 
for proper financial methods. If a borrower on 
commercial paper cannot pay his notes when due 
because of what is really misappropriation of 
funds, we get the matter settled as cheaply as 
possible, say "hard luck" to him, and very often 
lend him more money. This is a new country 
and as in all new countries matters often jump 
in unexpected ways, for they have no great fly- 
wheel of custom and proportion to steady them. 
Occasionally, kind treatment towards the maker 
of overdue notes is fitting; but it is not usually 
so and certainly it is not what should be expected, 
as often seems to be the case now, by the borrower. 

The Proceeds of Commercial Paper 
Should go into Merchandise Only. 

The use of commercial paper as a medium of 
finance is by its nature confined to the raising of 
money with which to buy stock in some regular 
business or to avoid selling that stock temporarily. 



THE FORM OF COMMERCIAL PAPER 35 

In this country much commercial paper is sold 
in order to raise money to buy machinery or 
other fixed assets. These arc no less valuable, 
perhaps, than the merchandise is, but there is 
solutely no hope of converting them into cash 
within the life of the notes, and notes issued for 
this purpose are not properly commercial paper. 
In the American method of issuing commercial 
paper it is difficult to separate the chaff from the 
ara in and we have no way of telling whether or 
not the particular dollars we lend by buying com- 
mercial paper go into merchandise or labor con- 
nected with the preparation of merchandise, which 
is the same thing, or fixed assets such as machin- 
ery, which is not the same thing at all. A com- 
pany may need to buy $100,000 worth of merchan- 
dise, which it can and does sell for $110,000, and 
put out $150,000 worth of notes, the $50,000 over 
and above the $100,000 needed for the merchan- 
dise going towards the purchase of land or machin- 
ery. If the notes are made on six months' time 
and the merchandise is sold at a profit of $10,000 
in this time, only $40,000 will have to be refunded. 
This the company can probably easily refund and 
keep on refunding till enough profit has been made 
pay the notes off. As it turns out, the extra 
>,000 notes are Bafe enough investments. They 
are flying under entirely false colors, however, 
when they are thrown in with pure commercial 
paper, and they should nol properly be used for 
financing the purchase of the land or machinery, 



36 COMMERCIAL PAPER 

It is good luck rather than anything else if they 
are taken care of at maturity. 

Commercial Paper Should Not be Used 
to Finance Fixed Assets. 

Such spurious notes as these, as we shall see, 
would not be tolerated in England or the other 
older countries. It will be argued that if the 
company is making $10,000 every six months, is 
in good standing, and so can refund its constantly 
decreasing amount of spurious commercial paper, 
there is no proper reason why it should not raise 
money in this way rather than put in more capital 
which is needed elsewhere. There is no reason 
why the company should not issue such notes and 
refund them ; but only provided some arrangement 
is made beforehand for the refunding in case the 
something arises which will make the general 
investing public refuse to take more notes. From 
the first axiom of borrowing in business, that bor- 
rowers shall prepare in their borrowing for the 
payment of the loan at maturity, to thrust a lot 
of notes on borrowers who can be only moderately 
well acquainted with the condition of the borrower, 
when at first sight it is apparent that if necessity 
arise the proceeds of such borrowing cannot be 
converted into cash to protect the notes, makes the 
thrusting of these notes on the public absolutely 
unjustifiable. If the notes are made to mature 
serially over a term of months, or if arrangements 



THE FORM OF COMMERCIAL PAPER 37 

are ma Jo with the company's own banks to protecl 
notes which cannot be renewed when renewals arc 
needed, the case is different. Too often, however, 

such preparation is not made. 

As a Rule Commercial Paper Cannot 

Carry Collateral. 

Inasmuch as the proceeds of commercial paper 
arc to go to the purchase of merchandise, it follows 
that from the nature of merchandise it cannot 
well he given as collateral. Commercial Paper 
is, therefore, usually an ordinary promisory note 
with* an collateral. As merchandise must be sold 
within the life of the note and as stock in trade 
must usually be exhibited and be in shape for 
immediate delivery to be sold to the best advan- 
tage, it w<»uid he injurious not only to the bor- 
rower but to the lender to require it as collateral. 
The credit of the borrower should be such as to 
make the lender ready to trust that he will buy 
merchandise and merchandise only with the money 
borrowed, or the form of commercial paper should 
be such a- to show that merchandise is brought 
to insure financing through commercial paper. 
No one should expect dry goods or heavy imple- 
ments to he turned over to the lender: but occa- 
oally a case arises where collateral iii the shape 
warehouse receipts or similar securities can be 
given as collateral, and where such <*a-<- exisl 
exceptions often <><-c\w to the rule that commercial 



38 COMMERCIAL PAPER 

paper shall not be directly secured. In the in- 
stance of the financing of the purchase of merchan- 
dise where there is an exceptional chance for 
fraud on the part of the borrower, it may even 
be necessary that some such collateral be given. 
The Boston News Bureau of February 16th, 1911, 
says, under the caption of "London Banking Com- 
ment on Cotton Bills:" 

"American bankers were much interested in 
reading this year's annual report of Sir Edwin 
Holden, chairman of London City & Midland 
Bank, because of his prominence in the negotia- 
tions which occurred in 1910 in connection with 
cotton bills of lading. The London City & 
Midland Bank had an unfortunate experience 
with forged and bogus bills of lading on cotton 
and was generally credited with authorship of 
the demand upon American bankers that they 
fully guarantee cotton bills of lading forwarded 
as the basis of bills of exchange. The report says 
in part: 

'The business as conducted on old lines placed 
European bankers and brokers at the mercy of 
any fraudulent seller of cotton who was allowed to 
reimburse himself by drawing bills of lading 
which might be forged. No system has yet been 
evolved which can be adopted with satisfaction 
to everybody concerned. Some additional security 
has been given by what is called a validation 
certificate, but still the railroads will be responsible 
for their bills of lading only in cases in which 



THE FORM OF COMMERCIAL PAPER 39 

their officers have received the cotton when the 
bills of lading and validation certificates are issued 
by them. It" the railway officers issue hills of 
Lading and validation certificates withoul having 
received the cotton, the risk will still lie on the 
European bankers and brokers unless the law 
intervenes. 3 " 

The instance of cotton is exceptional, but the 
3e of financing the carrying of grain until sold is 
often somewhat similar. Similar, too/ is the 
financing of the carrying of pig iron or of such 
merchandise as aging wines or whiskey. As a 
matter of fact, much of the commercial paper 
carrying warehouse receipts is paper on which 
no direct call for collateral is given. In many 
instances, in the case of financing merchandise, 
purchases in which warehouse receipts, bills of 
lading or the like for the merchandise exist, and 
lend themselves readily as collateral, the bor- 
rower, to show his good faith, of his own free will, 
put- them up a- security, making exchanges of 
collateral as need arises. Where collateral can 
he readily given, especially when in the form of 
I nited Stat*- bonded warehouse receipts, such 
-ild he given, a- it may encourage lender- to 
lend or t.. take the paper on which it i- collateral 
• rate ; hut. a- in the case of a man on 

trial who does not testify in hi- own defence, it 
.irilv injure credit it' collateral 
on commercial paper is qoI given, provided the 
lender treats nil borrowers alike. 



40 COMMERCIAL PAPER 

No Commercial Paper Should Run 
for More Than a Year. 

Commercial paper is a term occasionally 
broadened to include all borrowings, preparation 
for the payment of which may be made within 
a short time. As we have seen, commercial paper 
should not properly include any borrowings which 
are not made for the purchase of or to carry stock 
in trade. The time commercial paper shall run, 
that is, the difference in time between its sale and 
its maturity, is a somewhat more complex question. 
From a study of general business we may take a 
year as the longest time that commercial paper 
may be allowed to run. Only the very strongest 
borrowers, however, — those who by the nature of 
their business and a past history of successful 
operation show especial strength — should be al- 
lowed by lenders to make their commercial paper 
for as long a term as a year. The best mills, such 
as successful cotton mills, whose paper is endorsed 
by selling houses in the best of repute, are examples 
of such businesses. Occasionally because of at- 
tractive rates bankers who see by their study of 
fundamental business conditions that rates will 
probably decline, lend strong mercantile companies 
or firms for so long a period as a year, and do so 
with authority, not because it will take so long 
a period as a year to sell the goods bought, but 
because the lender is sure that when the first lot 
of merchandise is sold the proceeds will be used 



THE FORM OF COMMERCIAL PAPER 41 

to buy more merchandise, the result being the 

same as if the lender had renewed once or more 
an original borrowing. ( Jonversely, borrowers 

who study fundamental conditions arc justified 
in borrowing year money when statistics show 
clearly that rates will advance. The practice of 
allowing credit through commercial paper on mer- 
chandise which will undoubtedly be sold long 
before the paper matures is ? however, a dangerous 
practice, especially for those who are not fully 
familiar with fundamental business conditions and 
all changes which occur from week to week. For 
:l it is better for both the lender and the bor- 
rower to start anew with each individual trans- 
action. 

Most Commercial Paper Should Mature in 
From Ninety Days to Six Monti is. 

Most commercial paper should mature within 
six months, much within four months, much 
within ninety days. With any proper operation of 
commercial paper as a medium of finance, the 
rime the paper has to run will decrease with sixty 
to ninety day- as its limit. Foreign countri 
older communities than this, rarely have com- 
mercial hill- for six months' time Six months 
Bhould l»e taken in general a- the maximum time 
commercial paper shall be allowed t<> run, the 
varying maturities allowed being governed by the 

ivertibility of the merchandise back of them, 
and the foresight <>\ the principal- involved. Park- 



42 COMMERCIAL PAPER 

ing house paper, which is presumably secured by 
merchandise which has as ready a sale as almost 
anything, is especially safe and may be taken with 
safety for the full time, if the makers desire a 
six months' maturity. Commission merchants, 



such as those dealing in cotton cloth and selling 
for mills, or houses selling groceries and like 
goods, for which there is a constant demand, 
should also, if they wish, be allowed six months' 
time. 

Paper used to Finance Specialties 
Should Run a Short Time Only. 

Paper of manufacturers, say of a special form of 
shoe, the value of which is quick to change with 
fashion and the sale of which ought to be arranged 
for practically before the paper to cover the mer- 
chandise is put out, should not be made for over 
five months. Care should be taken, too, that a 
firm manufacturing a specialty does not renew its 
paper except under exceptional circumstances. 
Such renewals, if in any quantity, should be taken 
as a danger sign at once. Makers of heavy ma- 
chinery may or may not be given credit for so 
long as six months with safety. Usually, in the 
case of such borrowers, most of the machinery 
made is contracted for. If a customer is not 
ready to fill his contract immediately and yet is 
good, it is perfectly proper that the manufacturer 
should be given credit to carry his merchandise; 
but care should be taken that such credit is based 



THE FORM OF ( OMMERCIAL PAPEK 43 

on a firm basis. The trade accounts of the man- 
ufacturers of heavy machinery and the like, who 
make their paper regularly for the longest possible 
period, should be examined with especial care. 

Banks are Chiefly Responsible for the 
Form of Commercial Paper. 

Borrowers through paper cannot afford to waste 
time over very small denominations. As the turn- 
over i> necessarily fast for them, they must be 
able to borrow what they want quickly, and like- 
wise they cannot at maturity worry over a la rue 
number of small notes. If they cannot get their 
money in bulk from one place, they will go where 
they can so gel it. Hence comparatively few 
aotes are made in smaller denominations than 

,500 and most in at least $5,000 denomination. 
As the number of available individual investors 
who have money in this hulk to lend for not over 
six months is small, and as also it is chiefly the 
hank- who heretofore have best been able to pass 
on the worth of commercial paper, it is the banks 
who now do principally the discounting of such 
paper. Hence it is the willingness or unwilling- 
banks to accept commercial paper in certain 
forms thai is responsible for those form-. 

Banks Should Demand Their Bights 
More Firmly. 

It commercial paper doe- oot seem to be in 
proper form for proper finance; if. for instance. 



44 COMMERCIAL PAPER 

it is in the form of a six months' renewal of a note 
which it appears should have been retired for 
good and all at maturity, the bank asked to pur- 
chase it, even if it wants to make a loan, should 
not take it without much deliberation. It is 
absolutely the duty of the purchaser of commercial 
paper, for others as for himself, to inquire care- 
fully into the causes of a new note of the company 
in question being offered at that particular time. 
Unless absolute assurance of legitimate need is 
given, the note should be declined and, if possible, 
the matter made public. Occasionally a three or 
four months' note with proper explanation may be 
accepted where a six months' note may not. 

Endorsements, When Available, 
Should be Given. 

If banks feel that a certain company is con- 
trolled by very wealthy men, though weak in itself, 
they should insist on the endorsements of the men 
interested. Banks, it is the writers' belief, are 
not nearly enough insistent for their rights. There 
is much competition in this country between banks, 
too much so for the best banking, and risks are 
taken for fear that if they are not taken the chance 
for profit will go at once to another. It is a duty 
that all bankers, large and small, should recognize, 
and especially in regard to commercial paper, 
that they should hold out absolutely for what 
they perceive is the most proper form for their 



THE FORM OF COMMERCIAL PAPEB 45 

investments. This does not mean that they should 
demand ultra safety, but simply a proper con- 
servatism. Such action, even if individual, and 
far more powerful it concerted, will soon put an 
end to much of the loose financing of today, will 
protect the hanks and will, by exploiting a sound 
basis of finance, greatly strengthen the chance 
for a successful business on the part of the bor- 
rower. It is to be noticed especially that methods 
which are called for by lenders usually are those 
to which borrowers for their own good should 
turn, net so much because doing so will make their 
borrowings more attractive to lenders, but because 
such methods of financing their needs should 
insure the use of proper financial safeguards and 
keep borrowers from extending themselves unduly. 
Competition between lenders will see to it thai 
too much conservatism is not demanded. 

Receivables are an Excellent Form 
of Commercial Paper. 

Most of the money raised for merchandise here 
is obtained through the discounting of single aame 
paper, a form on which renewals are easy and 
in which loose financing is very possible. A 
-mall portion of our commercial paper takes a 
form which on it- face makes renewals difficult, 
rhis is tic- i*<.rm of receivables, where a sale of 
merchandise is made, a note given for it by the 
purchaser to the seller, who accepts it by endoi 



46 COMMERCIAL PAPER 

ing it and gets his money through discounting it 
himself through brokers or banks. As much 
trouble and explanation is necessary to get an 
acceptor of such a note to endorse another in 
renewal, most receivables appear but once on the 
market. When they .do appear, they necessarily 
represent real mercantile transactions. Some 
businesses, like farming or the purchase of raw 
materials, do not readily lend themselves to this 
form of finance; but many do so, a- great many 
more than make use of this system. It is interest- 
ing to notice how other countries look on this 
method of finance as compared with our more 
common method. The English have, of course, 
similar financial problems to ours. They, being 
an older and a less rapidly growing country, have 
paid more attention to details and have worked 
out. a conservative and yet a sufficiently broad 
system as to commercial paper for their needs. 
A short description of it and of the methods of 
dealing with this subject in one or two other 
countries should help us appreciate our own 
problems and their solution. 

The Bank of England. 

Quoting from the United States Monetary Com- 
mission Document entitled "Interviews on the 
Banking and Currency Systems of England, Scot- 
land, France, etc." on the interview with the Gov- 
ernor and Directors of the Bank of England, we 
find the following questions and answers : — 



THE FORM OF COMMERCIAL PAPEB 47 

Q. Can you state approximately the average 
length of time and the average Bize of lulls dis- 
counted by you I 

A. Time — forty to fifty days, size probably 
about £1,000. 

Q. Do your branches have business relations 
with merchants, farmers, and all classes of people 
in their respective localities 1 

A. There are no restrictions of any kind as 
to the class of people with whom the hank has 
business relations. 

(). [s the character of your discounts or loans 

gulated or restricted by law or fixed by the 
statutes of the bank ! 

A. Regulated by the court of directors from 
time to time. 

Q. Will you state (a) the class of bills usually 
discounted by you, giving the number of names 
required: (b) the minimum size, and (c) the 
maximum length of time to run? 

A. i a) Two British names, of which one must 
be the acceptor; (b) No minimum: (c) Four 
months, exceptionally six. 

It is to be noticed from this that although the 
Hank of England recognizes thai four and even 
six months' time is necessary often to conclude any 
mercantile operation, the working of it- system 

commercial paper finance in taking receivables 
or semi-receivables only, thai is, paper having 
the name of the man owning the merchandise or 
about to buy it and the man to whota it is to be 



48 COMMERCIAL PAPER 

sold, naturally tends to decrease the time that 
paper has to run to forty or fifty days. In other 
words, by eliminating the chance for speculation 
and by forcing borrowers to confine their opera- 
tions to conservative business, the Bank of Eng- 
land has brought borrowers to borrow for only 
such a time as they can see clearly ahead. The 
questions continue: 

Q. What is the distinction between what are 
known as prime bills and other bills ? 

A. A prime bill we should define as a bill 
accepted by a London or provincial bank in first 
class credit or a merchant or merchant banker of 
the first class whose business it is to grant credit. 

Q. Do you discount any but prime bills ? 

A. Yes. 

Q. What is the usual difference in rate charged 
by you upon a prime bill and for a high class loan 
secured by collateral having the same period to 
run ? 

A. It is impossible to give a precise answer 
to this question. 

Q. Is the rate for discount at your branches 
for customers' paper and for prime bills the same 
as at the central office ? 

A. The rates current in London are tele- 
graphed each morning to the branches for their 
guidance. 

Q. Do you at times discount bills for parties 
having no account with you? 

A. No. 



THE FORM OF COMMERCIAL PAPER 40 

Q. Do you allow overdrafts or do you make 
any advances of the kind made by Scotch banks, 
called cash credit- 8 

A. Except in special circumstances over-drafts 
are not allowed by the Hank. The Bank does not 
make advances of the kind termed cash credits 
in Scotland. 

Q. Is it the practice of the bank in times of 
stress to discount bills of a satisfactory character 
for its customers freely? 

A. At such times the Bank is always ready to 
discount bills of a satisfactory character for its 
customers or for the market. 

INTERVIEW WITH SIR FELIX SCHUSTER, BARONET, 

GOVERNOR OF THE UNION OF LONDON & 

SMITHES BANK LTD. 

Asked regarding the acceptances of the bank, 
Sir Felix Schuster explained that his bank 
charged, usually, about one-fourth of one per cent 
for accepting bills, tin's acceptance making bills 
prime bill-, lie stated that his bank would never 

<-pt a bill unless the acceptance of the bill were 
covered by negotiable securities deposited with the 
baid-:. tin- security being in the form of warehouse 
receipts, stock, bond-, etc., usually stock or bonds. 

Q. [s it the general practice in London to 
make advances to very responsible people on a 

jle name I 

A. Not in hoi i don. 

Q. Quite unusual? 



50 COMMERCIAL PAPER 

A. Quite unusual. The London banker's 
practice is only to make an advance against col- 
lateral; but in some of the country towns certain 
banks give over-drafts upon credits, particularly 
in Manchester, but local practices vary very much 
indeed. I think the practice tends much more 
to assimilate between country and London. It 
has become much more the practice in the country 
to ask and to get security against advances. 

London banks, it was explained further, and 
especially the bank of England, act as the banking 
pivot of the country. Most of the dealings are 
between banks, or bill (or note) brokers and banks, 
and only on secured or double name paper. If 
the bill broker takes a note to the Bank of England 
for discount he has to endorse it, if it is unen- 
dorsed, before it is acceptable. Hence only very 
strong note brokers can do business in England. 
Their position is criticised because in time of 
stress their endorsement is weakened. 

INTERVIEW W^ITH THE GENERAL MANAGER OF 
THE LONDON JOINT STOCK BANK LTD. 

Q. You show about $51,000,000 in bills dis- 
counted, loans and other securities. About what 
percentage of that item is in bills discounted? 

A. That fluctuates considerably according to 
the state of the money market. If my outlook is 
that rates will be lower in the course of the next 
three months, I hurry up to buy all the bills I 



THE FORM OF COMMERCIAL PAPER 51 

can possibly get today, and so I mighl have perhaps 
from thirty to forty per cenl on that in bills. 

Q. Whal is the character of those bills? 

A. Those arc all marketable bills, trade bills, 
— you know what they are— they are between the 
manufacturer and the man to whom he sells. It 
might be a promisory aote endorsed by the payee. 
Those are the two name- nn it; the payee perhaps 
is the manufacturer on a promisory note given 
by the purchaser. Instead of that here, our 
manufacturer draw- a bill on the person to whom 
he sells and that man accepts it. Those trade 
bill- arc good bills mostly, but we only discount 
those t<>r <>nr own particular customers, people 
whose affairs we know all about , but many of them 
are discounted in the open market to discount 
houses such as Nugent's. Then I buy bills with 
his endorsement, which is very valuable, and get 
money on these trade lulls from him. 

Q. Do you always require two names? 

A. Alw;: 

Q. What is the average length of time of these 
bills I 

A. Those bills are three months to run. and 

less. Wry occasionally 1 may buy a four months' 

bill or a six months' bill, just according to how 

I think it promises to be a profitable venture, but 

- a rule the three months' engagement is all I 

ay large extent [ want 
my money. We never rediscount, never turn the 
bills out again. It is enough to wail for their 



52 COMMERCIAL PAPER 

maturity; therefore it stands to reason I cannot 
afford to spend money for six months and sit there 
and wait for it. 

Q. Can yon give me an idea of about the 
minimum size of those bills ? 

A. ~No. They are of all sizes, from £100 to 
£10,000. From our own customers I take such 
bills as they have and they perhaps run mostly 
in small amounts, but from discount houses I 
do not want to be troubled with such small bills. 

Q. How does the small tradesman in London 
receive accommodation at the bank ? 

A. He must have some sort of collateral to put 
up. 

Q. As a matter of fact a small tradesman 
rarely has the collateral ? 

A. Then it is not much accommodation he 
gets. 

Q. It is difficult, is it not, for him to secure 
accommodation even through a guarantor ? 

A. No, if he gets a good guarantor. We do 
not care for guarantees as a rule because of the 
difficulty of enforcing them. 

Q. You have the accounts of many small 
tradesmen ? 

A. Yes, lots. They get accommodation, say, 
in our discounting trade bills. A manufacturer 
of any kind of tin goods or wood goods or anything 
of that kind — dealers in lumber — they sell to 
some other fellow in the country, or wherever 
it may be, and they draw that trade bill upon 



THE FORM OF COMMERCIAL PAPEB 

them at not more than three months from its date, 
and that these small traders may bring in to us 
and we rigidly scrutinize them as to the customer 

who brings them in, to see that he i> a respectable 
man. doing an honest business, and s<» we will 
help him by discounting those lull-, if we are 
equally satisfied with the acceptor, it we think he 
is .Icing legitimate business with honor, legiti- 
mate people. So he gets accommodation there 
without any security at all. We only get the 
security of another name. 

Q. The practice in England is for the whole- 
saler or large manufacturer to finance the retailer ! 

A. To some extent, but as a rule that whole- 
saler draws his bill on his retailer, and -«» he has 
a larger volume of these trade bills and he goes 
to his bank or to the Union Discount Company 
and discounts these in larger batches. 

Q. And in that way the retailer pays for bi- 
ds by an acceptance I 

A. Yes. 

Q. Which the wholesaler discounts? 

A. Y 

Q. If you had an account of a man running, 
say, a hat store, hi- account was satisfactory in 
character and had been carried with \<>u for 

era] year-, and lie wanted t.. stock up on hats, 
there would be no way in which he could go t<» 
you and borrow the money with which t<> buy 

through a guarantor 1 



54 COMMERCIAL PAPER 

A. No, he would then go to the wholesaler 
from whom he would buy the goods and give that 
wholesaler his bill, and that bill would be a dis- 
countable article, and that is how the money would 
be raised. 

It was pointed out that banking in London 
and in the country was very different. London 
banks and even their branches in the country, to 
an almost equal extent, confine their discount 
business to very short loans on trade bills, prime 
bills or such securities. They also accept bills 
when covered by a deposit of collateral, for such 
acceptance a charge being made. They do not 
wish other business. The so-called country banks, 
it was pointed out, come into contact with agri- 
culturalists and weaker borrowers than the London 
banks do. To finance them, overdrafts have often 
to be employed. This is the general practice in 
the country for financing such deals as this sort 
of customer has to enter. Overdrafts are, of 
course, only allowed by banks thoroughly ac- 
quainted with the borrower. Often they are 
secured. 

It was also pointed out that if a trade bill in- 
good shape was brought to the bank for discount 
and also a collateral loan secured by Pennsylvania 
R.R. bonds, the bank would discount the former 
at a lower rate than the latter. It was also shown 
that during the past year this bank earned about 
twenty per cent net on its paid in capital. 



THE FORld EAL PAPEE 

KRVIEW WITH THE MANAGER OF THE UNION 
MPAXY OF LONDON LTD. 

poration deals chiefly in selling com- 

rcial paper or bills to tin- banks in England and 
on the Continenl 

Q. Do ; "U guarantee all of the paper which 
you sell to the banks ! 

A. Y 5. 

Q. i U scribe the general character of your bills 

A. Th 3 of banks and financial 

firms e standing. The bills average about 
>0 in amount and about fifty - lays in 

rrency. At least two names are required. 

Q. What is the minimum size and what is the 
maximum leng to run for bills dis- 

■a I 

A. Rarely under £10 in size or longer than 

«. 

twelve months. 

Q. What is the distinction between what are 

- ud <»ther bills I 
A. Prime bills are the - ■:' banks 

; leading -. < Kher bills arc r. 

- = g aller p s 

lifferen • bill 

ill I I - same on each I 

A. A trade bill is one drawn (m a merchant 
goods - M and deliver 

A _ 



56 COMMERCIAL PAPER 

securities or sometimes without any such deposit, 
for the purpose of creating credit. Rate is higher 
on finance bills. 

Scotland. 

INTERVIEW WITH THE GENERAL MANAGER OF 
THE ROYAL BANK OF SCOTLAND. 

Q. Will you state (a) the class of bills usually 
discounted by you, giving the number of names 
required; (b) the minimum size; (c) the max- 
imum length of time to run. 

A. Mercantile bills, that is, bills for the price 
of goods or merchandise supplied, drawn by the 
seller and accepted by the purchaser, £2 or £3 in 
some cases, up to £5/10,000. Their maximum 
length is six months. 

Q. Do you discount to any considerable amount 
for individuals and merchants ? 

A. Yes. 

Q. Explain cash credits ? 

A. A customer applies to be allowed to over- 
draw such amount as he may require from time to 
time up to a specified amount, and he and two or 
three sureties jointly and severally become bound 
to repay the amount that may at any time be owing, 
with interest, on demand being made on them. 
Each obligant is liable to pay the whole sum, 
leaving him to obtain payment from his co- 
obligants. 



THE FORM OF COMMERCIAL PAPER 57 

INTERVIEW WITH THE GENERAL MANAGES 
OF THE UNION BANE OF SCOTLAND LTD. 

Q. Will you state (a) the class of bills usually 
discounted by you, giving the number of names 
required: (b) the minimum size: (c) the max- 
imum length of time to run. 

A. The bulk of bills discounted represent 
ordinary mercantile transactions. In practically 
every ease there are at least two obligants. The 
bulk of the bills discounted do not exceed three 
months' currency. It would not be practicable 
to indicate their average size. 

Q. Do you discount to any considerable amount 
for individuals and merchants? 

A. Yes. 

Q. Explain the phrase cash credits, and upon 
what conditions they are given I 

A. A cash credit is simply a current account 
on which the holder may draw to a fixed amount, 
interest being calculated and paid on the daily 
balance. In security the applicant and his sure- 

3, termed co-obligants, sign a formal bond under 
which they jointly and severally guarantee to 
repay the bank when called upon the amounl of 
the debt and accrued interest. 

INTERVIEW WITH THE GENERAL MANAGER 
OF THE COMMERCIAL BAN K OF 
I >TLAND LTD. 

Q. Can you state approximately the average 



58 COMMERCIAL PAPER 

length of time and the average size of bills dis- 
counted by von ? 

A. Two to three months' currency. 

Q. Will you state (a) the class of bills usually 
discounted by you, giving the number of names 
required; (b) the minimum size, and (c) the max- 
imum length of time to run ? 

A. (a) Trade bills, with two names, the drawer 
and the accepter. (b) No minimum, (c) Six 
months is the maximum in general. 

Q. Do you discount to any considerable extent 
for individuals and merchants ? 

A. Yes, it would be perhaps well to point out 
that in Scotland a large portion of the advances 
made to traders are granted in the form of over- 
drafts on current accounts. The number and 
amount of bills in Scotland are less now than in 
former years. Cash payments for the purpose of 
obtaining discount are more frequent, and the 
number of bills discounted by wholesale houses is 
reduced in consequence. 

Q. Explain the phrase cash credits, and upon 
what conditions they are given. 

A. A cash credit account is an operative cur- 
rent account in security of which the principal 
debtor and two or more co-obligants have granted 
a personal bond in favor of the Bank. 

Q. Is it the general practice in Scotland to 
make advances to very responsible people on a 
single name ? 

A. The general requirement is two names, but 



THE FORM OF COMMERCIAL PAPER 59 

each case is dealt with on its merits, and there are 
many instances where the full requirement is not 
insisted upon. 

These interesting interviews, all point ou1 I a I 
that in Scotland and England, whether in the Bank 
of England, in the great London hanks, which 
finance many of the large short time undertakings 
of the world, whether in the English country busi- 
ness dealings with farmers and small producer-, 
or in tin 4 larger business of the same kind thai 
comes to the Scotch banks, it is not regarded the 
thing to grant credit under the loose provisions 
that surround its granting in this country : 
<b> that in most cases, whether the credit is to 
be given in the form of an overdraft or cash credit, 
or in the form of discount, the names of at least 
two strong and interested parties are demanded, 
or in the case of the accepting of a bill to make it 
a prime bill and to put it in discountable form a 
deposit of salable collateral is required ; (c) that, 
owing to joint promises borrowers are forced into 
putting the proceeds of the notes they discount 
into those operations which are practically sure 
to arrive at maturity before the note comes due. 

France. 

INTERVIEW WITH THE GOVERNOR OF THE 
BANS OF FRANCE. 

Q. What classes of bills are discounted by the 
Bank of France I 



60 COMMERCIAL PAPER 

A. The Bank of France discounts for everyone 
who has obtained the opening of a current account, 
bills of exchange, checks, bills to order, and com- 
mercial and agricultural warrants of fixed maturity 
which have not more than three months to run and 
which bear the signatures of three persons, trades- 
men, agricultural syndicates or others, known to 
be solvent. The Bank and the Branches accept 
without distinction bills which are payable in any 
one of the 467 towns where we undertake to collect 
bills. 

Q. Do you require three names on all the bills 
you discount ? 

A. The statutory rule is that bills must have 
three signatures, but the Bank is also authorized 
to accept paper bearing only two signatures when 
the third signature is replaced by a deposit of 
securities belonging to one of the classes of securi- 
ties admitted for loans or by a warrant for mer- 
chandise (warehouse receipt). * At least two 
signatures on a bill must be given by parties 
domiciled in Trance. 

Q. Is it necessary that one of these signatures 
should be that of a bank ? 

A. That is not necessary. 

Q. Does your annual report show the average 
life of your bills ? 

A. Yes. The last statement of operations 
indicates * for the year 1907, — 26 days. 

Q. Does the statement of your operations give 
the average size of bills in your portfolio ? 



THE FORM OF COMMERCIAL PAPEB 01 

A. Yes. the average value of discounted bills 

in 1907 was 735 francs, in 1906 it was 683 francs. 

Q. Do you allow overdrafts or do yon make 

advances of the kind made by -the Scotch banks, 
called cash credits : 

A. The law does net permit any overdrafts. 

It was also pointed out that any depositor with 
the Bank of France may discount paper in as small 
denominations as 5 francs; also that the Bank 
of France has a monopoly of the issue of notes 
which may he legal tender. Those notes are 
s Hired by the hills discounted, as shall appear in 
the chapter on Banking. 

INTERVIEW WITH THE ADMINISTRATOR AND 

WITH OTHER OFFICIALS OF THE 

CREDIT LYOXXAIS. 

Q. Will you descrihe the character of the items 
constituting your portfolio of hills discounted 
which amount to about $211,000,000^ 

A. The bills discounted are commercial or in- 
dustrial bills, representing normal transactions 
and having satisfactory signatures as drawers, 
drawee- and endorsers. 

Q. With two name- or more I 

A. Always at leasl two, often three or four 
tatures, but never only one. 

Q. What is the Bize of your bills discounted I 

A. It is very variable, the average is perhaps 
about , » ,,, » francs. 

Q. While you do nol accept a hill with one 



62 COMMERCIAL PAPER 

name, you sometimes arrange with your customers 
to extend credit to them without guarantee, or 
without collateral ? 

A. Yes, that is quite right. * 

Q. Can you give us an estimate as to the 
average life of bills discounted ? 

A. The average maturity of the paper which 
we purchase daily is about 55 to 60 days. 

Q. Does the Bank of France rediscount bills 
for the other banks in France ? 

A. The Bank of France rediscounts all bills 
when the person presenting the bill is admitted to 
discount and when the bills have the necessary 
three signatures, have less than three months to 
run, and are payable in cities where the Bank has 
a branch. 

Q. You regard that item of bills discounted 
as your practical reserve because of your ability 
to rediscount the bills at the Bank of France ? 

A. Yes, bills discounted and cash are, for an 
establishment such as ours, the most essential part 
of our liquid assets. 

Q. Let us take up the question of discount 
rates. Do your large banks follow the Bank of 
France ? 

A. We have two discount rates — that of the 
Bank of France, which is the official one, and then 
the rate outside the Bank of France. At the 
present moment our discount rate is one per cent, 
the official rate being about three per cent. 



THE FORM OV COMMERCIAL PAPER 03 

Referring to overdrafts which the Credit Lyon- 
nais allows. 

Q. So that in fad they are what we would call 
overdrafts; they are funds adyanced with or with- 
out security I 

A. There would generally be security: it is 
only with very good customers and exceptionally 
that securities arc nor required. 

(). What dividend do you pay I 

A. Eleven per cent. 

(The Credit Lyonnais deals in securities). 

The Comptoir d'Escompte which deals with 
small tradesmen, will not discount paper without 
at least two signatures. 

The same is true of the Credit Foncier de 
France. 

INTERVIEW WITH A CHIEF OFFICIAL OF 
THE CREDIT AGRICOLE. 

The Credit Agricole deals especially with 

mers. It arranges i'<>v them long time loans 
or short loans with the privilege of renewal. The 

irirv is a mortgage on land and collective 
liability on the pari of many men interested in 
the loan, or else in the case of an individual farmer 
a note drawn on himself and signed by an officer 

the Credil Agricole, which is a co-operative and 
mutual institution to which the farmer belongs. 

is institution greatly aids the wine growers. 
No paper is taken by it unless it has the two sig- 
natures, the maker and an officer of the Credit 



64 COMMERCIAL PAPER 

Agricole. If the Credit Agricole has no money to 
lend a second officer endorses it to give it three 
signatures. It is then taken to the Bank of France 
and discounted there. 

Germany. 

INTERVIEW WITH THE OFFICIALS OF THE 
REICHSBANK. 

Q. You have in your statement bills discounted 
$221,000,000. Will you kindly describe the class 
of bills constituting this item? 

A. The law prescribes exactly the kind of bills 
the Reichsbank may take. They must not exceed 
three months in time and there must be on the 
bill the names of at least two parties known to be 
solvent. 

Q. Are the bills secured or unsecured ? 

A. They may be unsecured. 

Q. Would the Reichsbank discount a bill 
drawn by one merchant and accepted by another ? 

A. Yes. The Reichsbank is not only a bank 
for banks but for the commercial and industrial 
enterprises of the Empire. 

Q. Do you show what percentage of bills are 
secured ? 

A. ~No. It is the exception to have collateral 
because the bill is considered on its merits and 
accepted accordingly. 

Q. Have you any statistics showing the propor- 
tion of bills with two names and with three ? 

A. No. 



THE FORM OF COMMERCIAL PAPER 65 

Q. What is the smallest bill the Bank will dis- 
count I 

A. We have no minimum. We discount bills 
as low as 10 marks. 

Q. Upon what kind of a bill 'does the farmer 

lire an advance from the Bank? 

A. He sells his produce, draws a bill upon the 
purchaser, and takes the bill to the Bank as any 
other man would do, or a bill might be drawn upon 
a farmer and accepted by him. 

Q. When he borrows money in the spring with 
which to buy seed, how does he secure the cash? 

A. He goes to his own bank for that. There 
ire co-operative societies for this purpose, which 
arc a great factor in Germany. 

Q. Will the manager of a branch of the Reichs- 
bank renew a farmer's three months' bill if desired ? 

A. Yes. An exception is made for the farmer. 
Other bills are not renewed. 

Q. Are farmers required to maintain a balance 
in order r<» secure accommodation? 

A. People who hand in bills for discount are 
required to keep a satisfactory balance. 

INTERVIEW WITH THE OFFICIALS OF THE 
DEUCHE BANK. 

This is a private bank paying twelve per cenl 

lividends. It does not do much of a straighl 

bill discount business bul allows overdrafts or 

►ted bills, chiefly with America, Russia, etc. 



66 COMMERCIAL PAPER 

What business is done by discount is through 
receivables. 

All of these banks deal largely in collateral 
loans, as do the French and English banks, chiefly 
on approved stock exchange and Government 
securities. 

INTERVIEW WITH DIRECTORS OF THE 
DRESDNER BANK. 

This is a private bank paying seven per cent 
dividends. 

Q. Will you kindly describe the item "Bills 
Discounted" $51,000,000? 

A. The bills constituting this item are what 
we call prime and merchants' bills, running to 
ninety days, with an average maturity of from 
fifty to sixty days, and bear at least two good 
names. 

Q. Are these bills secured or unsecured ? 

A. They are unsecured. 

Q. Are most of these bills commercial bills ? 

A. Many of them are commercial bills. 

Q. You regard your item of "Bills Dis- 
counted" as one of practical reserve ? 

A. Yes, it is immediately convertible into cash 
at the Reichsbank. 

Q. We understand that your system here is 
such that when a merchant wants to borrow money 
for a legitimate purpose he arranges with some 
bank to accept his bill, which is discounted by 
another bank and which may be sold at any 



THE FORM OF COMMERCIAL PAPER 67 

moment or converted into cash through the Eeichs- 
bank ? 
A. Yes. 

INTERVIEW WITH THE SCHULTZE-DELITZSCH 
CO-OPERATIVE CREDIT SOCIETIES. 

These societies are for lending to their indi- 
vidual members on the liability of all members. 

Q. For what periods would the Schultze- 
Delitzsch Societies loan money ? 

A. Usually three months. 

Q. What class of paper do they take in making 
advances I 

A. They make loans in the form of cash 
advances or in the form of discounting bills of 
exchange. . 

Q. By cash advances you mean cash credits? 

A. Yes, they give cash against the obligations 
of their members. 

Q. How are these advances secured? 

A. Mostly by a guarantee of another member 
of responsibility, or by endorsement, or by a mort- 
gage as collateral. 

Q. They will take two name paper? 

A. Yes. They buy single name paper or 
extend cash credit against single named obligations 
with security or mortgage. 

The Canadian System. 

The Canadian Banking System is more like 
our own than is thai of England, France or Ger- 



68 COMMERCIAL PAPER 

many; yet it has absorbed much of the spirit in 
foreign banking and contains different practices 
from those found in the United States. Branch 
banking is extensively carried on, with the result 
that practically all the banks are very large banks 
and are able each one of them to do most of the 
banking business called for by any one customer. 
This has built up a very close feeling between 
bank and customer, a considerably closer feeling 
than exists between bank and customer in this 
country. Businesses are guided far more in 
Canada by the banks than they are with us. Most 
businesses use one only, rarely more than two 
banks, and largely adopt their finance to the sug- 
gestion of their bank or banks. This association 
is strengthened by a power given the banks in 
many cases to claim title to the merchandise of 
the borrower during the life of any borrowing 
from the bank by the customer. The merchan- 
dise, unless in the form of warehouse receipts, 
is not given, but an assignment of stock is given 
to be used if the bank considers matters going in 
a wrong direction. Borrowings, too, are arranged 
for at the beginning of a season for the whole 
season at a certain rate, not from time to time as 
need arises. That is, a bank says that such a 
company may have a maximum of credit and at 
such a rate, uniform for the drafts as they shall 
be presented. No other borrowings may be en- 
tered into without the knowledge of the bank. 
In the farming districts of Western Canada the 



THE FORM OF COMMERCIAL TAPER 69 

banks lend to farmers on their straight paper 
unsecured by mortgage, but not to buy land or 
to put up buildingSj only to buy seed, tools, stock 
or for wages, etc. The Western Canadian farmers 
are successful, a fact which, coupled with the 
purpose of the loan, ensures their notes to the 
hanks being good. 

We Seem Lax in Our Finance. 

In almost every country lenders are more in 
touch with the assets back of commercial paper 
than are the banks of the United States. Our 
method is to discount, as a rule, the single name 
paper of the borrower. This is perhaps a satis- 
factory form of borrowing in the ease of the bor- 
rower's <>\vn hank or hanks when the condition of 
the borrower can he kept closely in touch with. In 
tin- larger field, however, of borrowing through 
many sources at a distance from the place of busi- 
ness of the borrower, where lenders can be only 
moderately conversant with the condition of the 
borrower, such forms of borrowing, unless excep- 
tionally well protected, are unsatisfactory. Most 
of our commercial paper offered through respon- 
sible channels is a safe investment, but to insure 
s fety in commercial paper, where there is ob- 
viously much chance for leakage and unfair play. 

tain specifications tnusl be complied with which 

uhl qoI really be accessary. At the present 

time, we arc lending on commercial paper in this 

country fully as freely as are the hank- in Eng- 



4 



70 COMMERCIAL PAPER 

land, France, or Germany; but on paper which 
•is not nearly so well secured. In consequence, 
though commercial paper, owing to good business 
conduct, is generally in good repute, there are 
far more failures of it to bring payment at 
maturity than there should be, an amount which 
in volume is considerable. To protect themselves 
from such disaster American banks are now 
demanding that borrowers show a larger margin 
of safety, greater in fact than should be necessary. 

Borrowers Should Show Their Strength 
in the Form of Their Borrowing. 

It would be better for the borrowers, as has 
been shown already in the case of bonds, if they 
should make the form of their borrowings more 
attractive to lenders who cannot well be intimately 
conversant with their condition, for by so doing 
they could gain broader credit without injuring 
their own business opportunities. Occasionally 
they might not be able to gain credit where in the 
other case they could obtain credit; but as a rule 
in such cases it would be better for them not to 
obtain this credit. In cases where credit is 
deserved, by using some such method as a borrow- 
ing through receivables or by a form of distinct 
double liability on paper, lenders are far more 
ready to lend than they are under a vague form 
of borrowing. The result is that having shown 
the power back of their paper in the paper, the 



nerican Business Conditioi 



er area to be formed 
le size of the average 
oered that this next 
snt shape from any- 
:cording to whether 
wing that the areas 
' period by watching 
.•idly it is being con- 
ctive stocks, the red 
)lack line represents 
study of these lines 
-vhen the prosperity 
low point has come 



when the depressio 
money rates and h 
perity area and hl£ 
pression area. To 
ness, the observer 
the respective ares 
smallest. When u 
it refers to the min 
on the stock marl* 
also that this work 
other data and not 
dent thought and | 





Cowed 11 Sti .doners Hill. Londo. 



1910 1911 

mill!! 






36 

fst??k . a 

• 20 



*.i\.,4% 



-Rate, for Prime Commercial P»P" 



—■^—— •—Kates ««w «"»• — 

p rlce9! 32 active stocks showing Important 

declines and rallies. 

i -— . Prices: 10 active bonds. 

^e red fibres printed under 1909 refer to bjg-d^M, 

and show the price t hatt* otn The black figures 

l^lrZtf^rlf^ prime commercial paper 



THK FORM OF COMMERCIAL PAPER 71 

borrowers do not have to maintain so large a 
margin of safety in their business, to satisfy the 
Lenders. In other words, borrowers have more 
free capita] for their business. 

AVe Should Use Receivables or 
Similar Paper. 

The reason that we quote at such length on 
this subject, i> because the lenders and the bor- 
rowers of the United States must adopt this 
English and Continental system of loaning only 
on security and discounting only '"accepted bills" 
or "receivables/' before our reckless booms and 
severe panics can be eliminated. In addition to 
the increased security to the lender on such paper, 
the English system tends to prevent the borrower 
from becoming over extended and thus tends to 
nt the entire nation from becoming over- 
extended — a matter which would be a great bless- 

_ to the United States. In other words, if our 
country should adopt this system, the areas above 
and below the line of normal growth on the Com- 
• Plot of Business Conditions (herewith 
inserted) should gradually decrease in altitude 
and depth respectively and should tend to diminish 
in size. Moreover, with the additional security 
afforded by accepted bills over the ordinary one 
name paper, every person with capital would feel 
inclined to Btudy fundamental conditions more 
closely, knowing that they could at the proper 



72 COMMERCIAL PAPER, 

time safely and independently lend their money 
direct and not be so dependent on either banks 
or short time notes. As the number of those 
who study fundamental conditions increases, and 
more capital is kept alternating between fixed and 
liquid assets, this will still further tend to prevent 
over extension and to eliminate both the inflated 
and the depressed areas, above and below the line 
of normal growth — respectively. 

Note Brokers Have an Important 
Part to Play. 

Note brokers in this country are largely respon- 
sible for the present form of commercial paper. 
The note broker plays a very important part in 
the dealings in commercial paper in this country. 
The broker arose, first, because of the fact that 
there was no central method of finance ; secondly, 
because, owing to the size of this country, and lack 
of available capital for the needs in any one part, 
the note broker's facility in shifting his available 
supply of paper to the easiest money market aided 
the borrower very considerably; thirdly, because, 
owing to the newness of this country and its crude 
method of finance, borrowings through com- 
mercial paper needed additional checks over what 
the final lenders themselves could give. As an 
equilibrator in the supply of money in different 
parts of the country and as a checker of credit 
the note broker is serving an excellent economic 



THE FORM OF COMMERCIAL PAPER 73 

purpose. With no central discount market, his 
activity quickens very much the equalization of 

rates between centres and different sections. EEe 
also aids greatly in building up the business of 
the territory most in need of capital. Whether 
the note broker buys his paper outrighl or simply 
offers ir on knowledge that it can be obtained on 
request, he does much to help the financing neces- 
sary; but if he buy this paper, making direct 
advances against it in cases where general offer- 
ings are made, he is much more apt to investigate 
the conditions under which the paper is issued 
than he otherwise is. Buyers of commercial 
paper through note brokers should in all but excep- 
tional cases, therefore, take advantage of the 
additional check on credits by making sure that 
the brokers offering the paper have advanced on 
it themselves or -rand ready to advance on it. 

Where Single Xame Paper is Current 

Receivables Cannot Exist in 

any Quantity. 

Competition between note brokers is very keen, 
too much -<» for a- thoughtful finance as should 
1 editions with them, too, are much as 
with the hank-. For this reason, having adopted 
the placing of single name paper, they have done 
all they can to force any other form of similar 
finance oil the market. They cannot afford to 
let trade notes, for example, he discounted. To 
do this would permit a large volume of receivables, 



74 COMMERCIAL PAPER 

or preferred paper over the straight single name 
paper, to appear on the market. This volume of 
double name paper would necessarily hurt the sale 
of the single name notes, and in consequence 
brokers have insisted that their customers borrow 
in the market and then take advantage of trade 
discounts and pay for their merchandise soon after 
receipt. In a way, this practice is in theory 
correct; but it does away with the method of 
finance which from the lenders' standpoint is far 
preferable and it really does not better the situa- 
tion, for if the practice of financing needs through 
the discounting of receivables were generally in 
vogue, the seller of merchandise would get his 
money just as soon as he does now, if not sooner, 
and the ultimate result would be the same. It 
might be that the seller of merchandise would exact 
a tax of some sort on the buyer for the putting 
of his name on the buyer's paper, in order to have 
it discounted. On the other hand, the paper 
could be so much more readily discounted with 
the two names on it that this tax would probably 
be more than made up for in the rate at which 
the paper could be placed. Moreover, if this 
method of finance were generally practiced, com- 
petition between manufacturers would soon bring 
cost to the buyers down to where it is now. As 
has been shown previously, this method of finan- 
cing through two names is current in England and 
works very well there and has very many advan- 
tages over our present one of single name paper. 



THE FORM OF COMMERCIAL TAPER 75 

The Position of Xote Brokers is 
Likely to Change. 

A- this country grows older and richer, and as 
business becomes more conservative and not forced 

such a breakneck speed to keep pace with the 
opportunities which are constantly being opened, 
the need of note brokers will change. There Avill 
be fewer of them, probably, and those few will 
be the ones with the largest capital. They will 
be required to buy their paper with the greatest 
care and if not as in England to endorse it, they 
will assume more the position of the English, 
French and German banks, which accept paper 
for a commission and then let it go on to some 
other lender, than they do today. It is the prov- 
ince of the note broker almost as much as it is 

the banks to safeguard the giving of credit and 
where possible to remedy a state of affairs in 
which far too much commercial paper is not issued 
with proper authority. 

Cotton Bills are an Example 
of Our Problem. 

An example of what i- likely to develop in the 
forms which commercial paper will take in this 
country i- -ecu in the present day struggle over 
the financing of cotton bills. The English banks 
which supply much of the money for this financing 
have demanded thai other vouchers for the cotton 



76 COMMERCIAL PAPER 

shipped be given with the notes by which the 
shipments are financed than railroad bills of lad- 
ing, in which or under which many errors occur. 
It is suggested that the railroads guarantee the 
bills of lading or else that some substantial capital 
be proved to be back of the bills of exchange. 
This is a perfectly proper demand and as it seems 
unfair to bring the railroads into the matter other 
than to accept their bills of lading as they stand, 
for collateral, it would seem best that some sort 
of endorsement be given the bills of exchange. 
Many able men believe that to have this done 
would end at once a loose method of finance, which 
at the best does not lend distinction to this country. 
Such men are of the opinion that once this 
endorsement were given the bills, they could be 
placed so advantageously that the decreased cost 
in interest would more than make up to the bor- 
rowers the cost of getting the endorsement. 

Careful Finance Will Prevent 
Severe Panics. 

Notes which everybody knows are perfectly 
safe can be placed without the need of much out- 
side assistance. There are but few note brokers 
of today who could play a very large part in the 
financing of the cotton crop if the cotton bills of 
exchange or notes for cotton were financed through 
bank or other strong endorsements. So in other 
lines of business. Just now we are all imbued 



THE FORM OF COMMERCIAL PAPER 77 

with a great desire to take risks, and in conse- 
quence it will probably be a long rime before any 
general method of finance of merchandise in busi- 
ness, as is suggested for foreign sales of cotton, 
is current here. The sooner it comes, the better, 
however, for though we may go ahead a bit more 
slowly under it. the delay will not be great and 
the gain made in decreased interest charges and 
in insuring that our liquid capital shall be kept 
liquid, together with the aid this will give us 
in lessening the severity of further panics, will 
more than counterbalance our loss. 

Registration of Commercial 
Paper is a Help. 

There is an extensive movement on foot at the 
present time for the registration of commercial 
paper with some responsible agent such as a bank. 
That i-. a borrower registering his commercial 
paper will go to the registering agent with his 
by-laws and other data -hewing his authority to 
borrow, and will ask the registering agenl to 
number and to endorse the note- after investiga- 
tion, to the effect that the registering agenl thereby 

tea the note- of a certain linn. Nbs. A to X 
inclusive, are issued with authority, and if any 
amount is specified that they do qoI exceed the 
amount of borrowing authorized. To the buyer 
paper such registration ha- many obvious 
advantages. It will make borrowers far le<s care- 



78 COMMERCIAL PAPER 

less as to the form of their notes ; through the fear 
of open criticism it will make them hesitate to 
borrow beyond their plain needs. It will largely 
make public and give the advantages accruing 
from publicity to their borrowings against mer- 
chandise. 

Eegist ration is Not the Best Eemedy. 

The borrower, however, apart from the check 
he will receive on extensive borrowings, will find 
often many disadvantages in such a system of 
frequent registration of his paper. It may dis- 
close at once to many eyes the volume of his 
yearly business, his need or lack of need for 
money, and many other things which, although he 
may be doing a perfectly legitimate business, he 
does not want outsiders to know. The registering 
agents, however honest they may be, can hardly 
withhold this information from all. If even the 
directors of a registering bank have opportunity 
to look over a list of the bank's registrations, it 
may do harm. Too often, bank directors do not 
feel the moral obligation towards the customer of 
their bank that they should. To require gen- 
erally registration of commercial paper would do 
much good but would bear unduly hard on many 
legitimate borrowings. The system is a poor sub- 
stitute for the receivable method of borrowing. If 
a need for it exists, it shows a rather pitiful con- 
dition in the issuing of commercial paper. It 



THE FORM OF COMMERCIAL PAPER 79 

points to lack of understanding of the proper use 

of commercial paper, general extension of credit 
and dishonesty. If we really have to deal with 
these tilings, let us go deep enough to cope with 
them in body and not use a superficial check on 
them, which at the best must be crude in its opera- 
tion. 

Most of Our Commercial Paper is Good. 

A- a matter of fact, most commercial paper in 
the United States is good and issued on a sound 
basis. Some are too apt to emphasize errors that 
occur in it as expressive of its general condition. 
Many errors do occur, more here than in other 
countries, and we should, if possible, devise ways 
for cutting their number down ; but at the most, 
though their volume may be fairly large, their 
average is only a very small percentage of the 
total amount of paper discounted by lenders with 
any competency as to judging credit. We have 
to guard against many chances for error which we 
must recognize as existing, but lenders need have 
no fear of not being able to find in the general 
commercial paper market a sufficient supply of 
good commercial bills to discount, in any but 
exceptional times. Lenders must pick and choose 
carefully, that is all, and pay attention to certain 
rules \'<>v buying paper, thai under a different sys- 
tem would not have to be laid down. When bor- 
rowers recognize the importance for their own 



80 COMMERCIAL PAPER 

sakes of avoiding improper finance, as they would 
avoid disease, a much healthier condition, with far 
fewer errors, will exist. In the meantime, the 
commercial paper market in this country offers 
a most profitable field for bank, individual and 
corporate investment. 

The Amount of Commercial Paper 
Outstanding is Enormous. 

Loans and discounts are given for our National 
banks on January 7, 1911 as $5,402,642,351.82. 
If we suppose that forty per cent of this amount 
is in commercial paper, and that the average length 
of that paper is five months, we see that approx- 
imately $5,186,536,657.75 of commercial paper is 
discounted every year by the National banks alone. 
When we realize that the data taken was before 
much of the crop money had found its way 
back to the banks and was available for discount- 
ing commercial bills, we see that this is a con- 
servate estimate of the paper taken in this way. 
To be added to this amount is the paper discounted 
by trust companies, state and savings banks. Tak- 
ing this amount as a third of the other we have 
$2,881,409,254.30 as a total amount for com- 
mercial paper discounts in this country at one 
time. This is a very large sum, sufficiently so to 
warrant great attention, both as to the amount 
and as to its adaptability for its purpose- as a 
means of raising money and as an investment. 



THE FORM OF COMMERCIAL PAPER 81 

Commercial Paper Proved of Great 
Assistance in the Last Panic. 

During a recent panic an official of a groat 
Chicago hank said that he did not know what he 
would have Jonc if it had not been for his com- 
mercial paper which matured during this panic 
and from which he received his money. This 
was the case, doubtless, with many, and it is the 
way it ought to have been with every bank. As 
a matter of fact, however, much of the com- 
mercial paper outstanding at the beginning of the 
last panic and maturing during it was not paid 
in full, if at all. This was not all the fault of 
the makers of the paper. There was no sale for 
commodities except at enormous sacrifice and 
holders of them for their own salvation had to 
beg assistance of the banks holding their paper 
to renew at least part of the paper held and 
(•Mining due. This the hanks as a rule very 
properly did, one-half being the proportion usually 
allowed for renewal. If this had not been done. 
enormous trouble would have occurred. Our last 
panic was serious enough as it was: hut it verged 
on something that was terrible and t<> which what 

jurred wag nothing. Only broad minded finance 
'»n the part of bankers throughout the country saved 
the day. Commercial paper appeared well during 
tlii- crisis, but it ought t<> have appeared even 
better than it did. 



CHAPTER III 

THE SELECTION OF COMMERCIAL PAPEE 

WE have seen that commercial paper, if it 
is properly issued, is one of the safest 
forms of investment that can be had. 
We have also seen that unless commercial paper 
appears in the form of receivables or double name 
paper, that is, in the form of notes bearing the 
names of two responsible and distinct parties to 
a transaction in merchandise, it is somewhat 
difficult to guard against spurious commercial 
paper or notes issued for other than merchandise 
which is to be sold during the life of the note. 
An enormous amount of commercial paper is in 
circulation, practically all of it good at bottom 
but with a tendency in much of it to represent 
transactions which may not arrive at maturity in 
time to pay off the notes when they fall due. 
Too often, also, commercial paper in this country 
represents transactions in which there will occur 
absolutely unnecessary loss. 

Rules for the Buying of Commercial 

Paper Have to be Very 

Conservative. 

It is now our task to lay down certain laws 
which should provide for the selection of com- 
mercial paper as it exists with us today with 
safety, without proving too great restrictions on 



THE SELECTION in- COMMERCIAL PAPER 83 

the borrower. Rules are always a momentary 
drag and they are things to be avoided if possible. 
Often they bear unduly hard on certain people 
governed by them: but they have to be made 
sufficiently wide to cover all classes, and this 
should be borne in mind by those on whom they 
tir and who do not need them. Rules for the safe 
buying of commercial paper must necessarily be 
especially conservative, tor they have to protect 
as nearly a- can In- those who lend what is apt to 
he their dearest as>ot, money. 

Where Possible Every Case Should be 
Considered on Its Individual Merits. 

The following cannot insure absolute safety, 
nor can they he made hard and fast. Every case 
should be considered individually as much as pos- 
sible, especially where commercial paper is pre- 
sented for discount at the borrower's own bank, 
where intimate knowledge of the borrower should 
guide more than anything else the amount of credit 
to ho extended. For the general purchase of com- 
mercial paper, however, particularly in the case 
of lenders who cannot have an intimate knowledge 
of the borrowers, the following should suffice to 
insure the buying of paper with the confidence 
afforded by other forms <>t" investment, and at the 
same time not offer restrictions which will bear 
too heavily on the borrowers. The disregarding 
of any one <,f these rules should occur only with 



84 COMMERCIAL PAPER 

certainty as to conditions in the mind of the 
lender. 

(a) If possible buy receivables. 

There is so much commercial paper in the 
market that is good and that is not in the form of 
receivables that it may seem an undue restriction 
to limit at first the purchase of paper as largely 
as is possible to this class, but there is no better 
method of proving the worth of paper than by 
finding a strong firm or corporation which is not 
the real borrower ready to endorse that borrower's 
note. Not only does this endorsement act as a 
check on the goodness of the original note, but it 
brings with it usually at least as much strength 
again as the original name carries. Such paper 
in our market, therefore, is like the prime bills 
current in England, which bear the endorsement 
of some powerful bank. These receivables would 
not be classed abroad as prime bills ; but compar- 
atively speaking they appear as such with us, and 
they should without question claim a lender's first 
attention whenever they are offered. It should 
be noticed, however, that commercial paper having 
the endorsement of a firm or corporation which, 
controls the original maker of the note, may not 
be as satisfactory as paper which carries the names 
of two separate and distinct mercantile companies. 
The wheel within a wheel system should be 
watched, if not guarded against. 

(b) In buying other than local commercial 



THE SELECTION OV COMMERCIAL PAPER. 85 

paper, buy only through an accredited agent 
such as a note broker in good standing. 

Good business is tie taking advantage of oppor- 
tunities with the least possible risk. When it is 
possible to choose investments in commercial paper 
which have been passed on by a competent judge 
of credit, one whose business it is to specialize in 
picking out the best notes that can be obtained 
for the market and whose success is largely 
dependent on the reputation made by such selec- 
tion, it is foolish not to take advantage of such 
judgment and to pass over offerings made through 
this source in favor of paper offered by untried 
judges of credit. In buying paper a purchaser 
should always, if he cannot have a personal 
acquaintance with the conditions under which it 
i> issued, take paper which conies from a bank 
or a reputable and tried note broker only who has 
passed on it. There is plenty of such paper that 
is available and there is no need to go outside of 
this held. If possible, too, the purchaser should 
make sure that, unless for some obviously good 
reason, the broker offering the paper has himself 
bad faith enough in the note to advance against 
it. If the paper has been registered with some 
bank, all the better. 

(c) Make sure that the men connected with 
the firm or corporation issuing the paper be 
known to have absolute integrity. 

There is no rule in the selection of commercial 
paper which is more important than tlii>. In 



86 COMMERCIAL PAPER 

order, it comes third, but not so in relative im- 
portance. On the integrity of the men issuing 
the paper in question the ultimate payment 
entirely depends. Without honesty, ability and 
shrewdness go as nothing. If purchasers of com- 
mercial paper are to be at the beck and call of 
dishonesty they are entirely without protection. 
There are many chances for error, as we have seen, 
in our present method of finance. It is satis- 
factory, if made use of with good intent on the 
part of the borrowers to conform to its proper 
laws and if that intent is carried out, not other- 
wise. Any borrower who has a history of fraud 
or semi-fraud should be looked into most carefully, 
and the first question that a possible buyer of 
paper should ask is if the moral risk in the note 
offered is all that can be desired. The lender 
should not only ask this question, however. He 
should assure himself by every possible means that 
such is the case. He should ask for references and 
should check them up, and he should inquire at con- 
siderable length through sources other than those 
given as references regarding the personnel of the 
company borrowing. Fraud is the one thing 
which it is hard to guard against in business. 
Protection from weak or faulty business methods 
can be had fairly easily, but not against wrong 
doing. As a matter of fact it will be found that 
most of the losses in commercial paper came not 
from poor business methods, but from lying or 
other form of dishonesty. 



THE SELECTION OF COMMERCIAL PAPER 87 

(d) The firm or company issuing the paper 
offered should be proved to have been successful 
over a period of years under its present manage- 
ment. 

There is a tremendous impulse for rapid 
advancement with us, which is as it should be; 
but this advancement should at first be watched 
carefully by those competent to judge of and guide 
its progress. This guidance is one of the chief 
duties of bankers, who are necessarily tried 
business men of large caliber and with many re- 
sources as to knowledge of conditions. A new 
company should at first be financed by banks 
which it selects as its own and it should not for 
a time be allowed to force itself on the general 
public for aid in financing its projects. More- 
over, there are few companies which can afford to 
plunge headlong on a large scale into the business 
world. Some department stores, for example, 
managed by competent men, may be able to do 
this successfully; but even with them it will gen- 
erally be found more advantageous to begin on a 
comparatively small scale and feel their way up 
along the Lines of least resistance. Certainly it 
is the rule that the mosj successful businesses are 
those which have done tin'-, and it is the exception 
where they have not. A- buyers of commercial 
paper wish primarily to -elect the strongest busi- 
nesses to lend their money to, they should pick out 
tlu- paper of those which can -how ;i creditable 

>rd over a considerable term of yc;\r>. A>, 



88 COMMERCIAL PAPER 

too, a change in management of a company is apt 
to be a critical moment in a company's affairs, 
buyers of commercial paper should if possible take 
only the notes of those which have been under 
a tried management for some time. 

(e) Buy paper of companies and firms dealing 
only in staple commodities, for which there is a 
steady demand and which are not luxuries. If 
the company or firm deal in other than such 
commodities an additionally strong showing should 
be required. 

Since the proceeds of commercial paper are to 
go into merchandise which is to be sold or which 
can be sold, presumably at a profit, before the 
maturity of the notes given to raise the money for 
it, the goodness of the paper is dependent on the 
chance for the sale of the merchandise for a sum 
at least equal to the amount borrowed. Hence 
paper which has back of it merchandise for which 
there is a steady demand, and which is little likely 
to fluctuate in value, is the most satisfactory paper 
to select. Merchandise which may rise greatly 
in value is usually to be classed as speculative, and 
hence is as likely to fall in price as to rise. Paper 
given for such stock in trade should, therefore, 
show a far larger margin of safety than that car- 
ried by staple commodities. Compare paper 
issued for wool with paper for a special print in 
cotton cloth which is momentarily the fashion, or 
with paper issued to purchase or to carry shoes 
of a special make for which there is a narrow 



THE SELECTION OF COMMERCIAL PAPER 89 

market, or paper issued for automobiles. Paper 
issued for commodities which cater only to the 
fashion, or which are to be classed as luxuries, 
should be very carefully protected* 

(fl Make sure that the company or firm issuing 
the paper offered shows on a recent statement at 
least two and a quarter in quick assets times debt 
and no mortgage debt. Or, if there is a mortgage 
debt, the two and a quarter in quick assets should 
be in addition to other than quick assets of at least 
several times the mortgage debt. 

By a recent statement the writers mean one cer- 
tainly within a year and much preferably within 
six months. Many firms engaged in certain trades, 

•i as the handling of raw materials like wool or 
cotton or grain, clean up or go out of debt in one 
vy year. Wool, cotton and grain and 
the like arc commodities which can be secured 
only at certain seasons. They are purchased in 
very large amounts at this time and the rest of 
the year is -pout in selling them. An attempt 

usually made to sell all of these commodities 
purchased before a new buying season comes. 
Such firms as deal in these naturally make their 

tement when their condition is strongest, thai is, 
at the end of their period of selling, and although 
if possible the debt at it- height should be ascer- 
tained and compared with the merchandise cover- 
ing it, this :' a company liquidates so thor- 

ghly once every year, and its merchandise is bo 

ible, that a yearly statemenl should suffice. In 



90 COMMERCIAL PAPER 

the case of companies manufacturing heavy ma- 
chinery or dealing in other than seasonable mer- 
chandise, a statement at least every six months 
should be required, so that the progress of the com- 
pany may be carefully watched, and so also that 
the company may have a check kept on it from 
doing too much business for safety on its capital. 
To have a year pass without such companies as 
these making any return, is too long a period. 
Also, in the case of companies which for any 
reason have great delay in getting out their state- 
ments, semi-annual statements should be- called for. 
To have paper offered on a statement fourteen or 
fifteen months old should invite denial of credit. 

Two and a Quarter of Quick Assets to 
One of Debt is a Fair Ratio. 

Two and a quarter of quick assets, that is, assets 
which can be converted readily into cash, to one 
of debt, has been taken as a fair showing to be 
called for on an annual statement. As has been 
seen, in the case of a dealer in grain, wool or the 
like, a stronger showing than this once a year 
should be exhibited. On the other hand, permis- 
sion should be granted by lenders to such dealers 
to buy up to a considerably smaller ratio than 
2-1/4 to 1 during the buying season. The ratio 
of 2-1/4 to 1 should be regarded as a fair ratio 
to be expected on the statement of the average 
mercantile company, and most borrowers of this 



THE SELECTION OF COMMERCIAL PAPER 91 

class in the open market, under our present sys j 
tern of commercial paper, ought to show this much. 
Packing houses, which have chiefly assets ^( an 
exceptionally quirk nature, may possibly be ex- 
cluded, for the packing business is such thai the 
buying of raw materials can be stopped at any 
time, with the result that in a very shorl while a 
large part ^\' the assets of the firm in question can 
he liquidated. Packing houses, therefore, may 
with safety, if they arc in good repute, ho allowed 
jasionally to show statements of less than two 
and one quarter of quick assets to one of debt. 
With them, however, over a series of years there 
should he several statements showing at least this 
ratio. 

There are Some Other Exceptions 
to This Rule. 

Another exception is that of a company buying 
raw materials to till contracts already taken or 
clearly in sight. As there is presumably a profit 
in the contracts taken, such a business as this, if 
the contracts are good, i- especially safe. Even 
if the contract- call for delivery some time hence, 
as much a- six months, during which the raw 
materials must he changed by manufacture into 

finished product, paper of such firms may be 
taken with confidence on a statement showing 
somewhat less than 2-1 I to l. ('are should he 
taken, however, to make sure that the contracts 



92 COMMERCIAL PAPER 

are sound and that full insurance is carried on the 
merchandise till delivered. 

Most Borrowers Should Conform 
to the Rule. 

In considering the statements of manufacturing 
companies such as mills, unendorsed by selling 
houses, or by selling houses endorsing paper of 
a mill which does not show 2-1/4 to 1, or of 
department stores, dry goods houses, manufact- 
urers, and the like, 2-1/4 to 1 should be set 
as an entirely fair ratio to be expected, and if 
possible, as has been shown, semi-annual state- 
ments making this showing should be obtained. 
The mere fact that a borrower must make such 
a showing will tend to keep him conservative. 
Yet this ratio does not call for so large a margin 
of safety as to endanger his business success. A 
yearly statement on the part of a manufacturer 
will be sufficient to make the borrower draw in at 
least occasionally; but semi-annual statements, 
especially in the case of companies dealing in mer- 
chandise which takes a considerable effort to sell, 
will tend to make borrowers able to make this 
showing practically all the time. The reason is 
that very few companies can extend themselves 
much beyond a ratio of 2-1/4 of quick assets to 
1 of debt, and then draw in again to this ratio in 
time to make statements of such a condition every 
six months. 



THE SELECTION OF COMMERCIAL PAPER 93 

When Credit is Working Freely This 
Ratio Should Still be Required. 

When credit is working freely, when it is 
apparently in good condition, and especially when 
capital is scarce, the call for a showing of 2-1/4 to 
1 may seem to bear hard on the borrower; but it is 
in just such cases that the call should particularly 
he made. It is in the places distant from the 
capitalistic centres that such conditions exist; and 
it is unfair for borrowers in these communities 
t<> expect lenders to send their money far from 
their sight on a showing which represents a very 
much extended credit, even though that credit be 
apparently healthy. Xo matter how good oppor- 
tunities exist, extension of credit is apt to break 
itself. In a new country, prices of commodities 
are apt to fluctuate very widely. To lend money 
in a new country or in an undeveloped part of a 
country in which such conditions may at any time 
arise, on a statement which shows a tendency on 
the part of the company to stretch its credit to the 
utmost, i- a most dangerous practice. All of the 
I nited States is a new country. It has great 
opportunities. It ha- also too little capital for 
business. Probably there have been more 
failures in this country from too greal an exten- 

q of credit, that is, from doing too much busi- 
ness for the capital employed, than for any 

er reason. It behooves as to advance with 
our weight on our feet all the time. With chance 



94 COMMERCIAL PAPER 

for error in the security given commercial paper 
and with a country showing wide fluctuations in 
the prices of its merchandise, 2-1/4 of quick assets 
to 1 of debt is not a bit too large a ratio to be 
required at least once a year on a statement. 

Liquid Assets are Essential. 

A review of the business which paper under 
consideration represents, both in its broad and in its 
specialized aspect, is also of value. Mr. Edward 
D. Page says in "Commercial Paper as an Invest- 
ment/' a paper read before the Pennsylvania 
Bankers Association, "in buying commercial paper 
prefer the businesses where there is normally a 
large proportion of fluid or automatically liqui- 
dating assets, and a small proportion of assets that 
are liquidated with effort, or with expense, or 
both." With this in mind, and as an example of 
the way in which paper may be tabulated, Mr. 
Page goes on to analyze the dry goods trade into 
four classes, that of manufacturing establishments, 
that of retailers, that of jobbers and that of com- 
mission houses. Comparing the paper of these 
classes on the basis of average fluid assets, he finds 
that commission house paper comes first in rank, 
then that of jobbers, next that of retail stores and 
last that of mills. "Of commission houses/' Mr. 
Page says, "there are four classes/' one the selling 
agent with responsibility but without capital 
actually invested in its business, one the finance or 
mercantile house which has no selling organization 



THE SELECTION OF COMMERCIAL PAPER 95 

hnt simply advances on merchandise and cash sales 
made by its departments with which commissions 
are divided, one the commission hotise which owns 
it- accounts receivable, guarantees sales and 
advances on merchandise, and finally the class of 
commission houses "who own the mills they sell 
from or are owned by the mills they sell for." Such 
subdivision of trades and the selection of com- 
mercial paper with reference to the comparative 
tabulation, on the basis of liquid assets and inde- 
pendent strength, cannot fail to be a source of 
protection in the buying of short time notes. 

A Bonded Debt is Sometimes Desirable 

for a Borrower. 

Many mercantile companies need to borrow 
money for a considerable time. Tt is far better for 

•:i companies to fund their debt or to raise 
money by an issue of stock than by other methods. 
By issuing mortgage bonds they gain considerably. 
Many buyers of commercial paper feel that if a 
company shows a mortgage debl they should not 
lend on the company's paper. If the bonds are 
properly secured, this is entirely erroneous. A- is 
shown in the chapter on Borrowing and Lending, 
bonds and commercial paper have very different 
fields and they should not be forced to coincide in 
any way. Briefly, bonds should be secured by four 
times their face ralue in a fair appraisal value of 
the fixed assets they cover, It' such an appraisal 
is given as a fair salable value, nol necessarily an 



96 COMMERCIAL PAPER 

immediate salable value but one which should be 
obtained within a year if the need to sell arose, the 
bonds may be regarded as properly secured, pro- 
vided the earnings of the borrower are normal. 
When bonds are outstanding, however, buyers of 
commercial paper should not purchase paper of 
companies in which the bonds mature within the 
life of the notes taken, unless arrangements have 
been made to pay the bonds off. Also, in the case 
of companies having bonds outstanding, purchasers 
of paper should make sure that there is no question 
for the immediate future of non-payment of in- 
terest. 

(g) Make sure that the statement of the com- 
pany whose paper is being considered for purchase 
does not show evidently an over large amount of 
notes receivable, and make sure also that the 
merchandise shown as being carried is appraised 
at a fair market value. 

In the analysis of a statement of a mercantile 
company, great attention should be paid to the 
item of notes receivable. It is difficult to name a 
rule as to what shall be a safe amount of notes 
receivable to carry. It is presumed that the pur- 
chaser of commercial paper has a general acquaint- 
ance with the trade in which the paper appears 
and access to information as to the nature of the 
business being done by the maker of the paper. 
It is for the purchaser to make up his mind 
whether or not the company is carrying too many 
customers or is carrying its normal number of 



THE SELECTION OF COMMERCIAL PAPER 97 

customers for too long a time. The notes receiv- 
able item is the key to the situation as to these 
conditions, and if it appears unduly large when 
compared with the notes receivable item in the 
statements of similar companies, it should be 
garded as a danger signal. The danger is, of 
course, that when customers evidently are not 
paving cash for their goods, or when their cus- 
tomary notes or other forms of promises to pay 
are being let run for an unusually long time, there 
is a good chance that the merchandise which is 
the real security back of the commercial paper 
of the firm in question is not being kept in as liquid 
Bhape as it should be. 

The ^Eereliandise Item on a Statement 
Must Eepresent a Fair Valuation. 

That the merchandise item on a statement 
should represent a fair valuation speaks for itself. 
Tt i- surprisingly often, however, that merchan- 
dise ..n ,-i statement does not represent such a 
valuation, and buyers of paper should not fail to 
r this item most carefully. Tt is a safe 
rule to require merchandise to be carried by the 
owner on bis statement at cost when the market 
is equal t.» or better than cost, and at the market 
res f<»r the merchandise when the market is 
below cost. An exceptional amount of merchan- 
dise, a- shown by a statement, should also be 
inquired into. 



98 COMMERCIAL PAPER 

(h) Make sure that the statements shown be 
audited or come through persons entirely compe- 
tent to judge of their correctness. 

In a system like ours, where there is not the 
check on credit that the endorsement of a bank 
or of a second party to a transaction gives, it is 
important that some competent and disinterested 
person consider the condition of the borrower most 
intimately. Even if the borrower is entirely 
honest, he may be carried away with his prospects, 
and like the real estate dealer, who figures his 
worth at the highest prices his land will bring 
before he has sold it, mark up the value of his 
property without authority. There is a large 
chance for statements which are not set before 
a disinterested person for judgment to express a 
warped situation. For this reason a demand 
should be made that every statement shown of a 
possible borrower should at least be a copy of a 
signed statement, and that the statement has been 
passed, if possible, by an auditor. If an auditor 
has not passed on it, a note broker or bank, which 
has a full knowledge of the trade in question and 
of the company whose borrowing is under con- 
sideration, and who has really studied the value 
of the statement as a true representation of condi- 
tions, should pass on the statement. Too often 
note brokers and banks refuse to give such study 
as is necessary to a statement, simply passing it 
on as it comes to them. Brokers and banks who 
are found to do this should be avoided, 



THE SELECTION OF COMMERCIAL PAPER 99 

(0 Make sure that the borrower keeps one or 
more bank accounts in a large city near the lender 
with banks which will vouch for the goodness of 
the company's paper. 

If the company in question is in a country town, 
at least two of the banks in its home town should 
vouch for it besides one reputable bank in a larger 
city. If the company is in a large city, at least two 
banks in that city should report favorably on it. 

Home banks are among the best references a 
borrower can have. If a borrower cannot satisfy 
his own banks of deposit, that he is good and 
that he is deserving of credit beyond what they 
will give him, he should not be allowed outside 
credit. There is no danger that in order to profit 
themselves from his borrowings his own banks 

old report adversely on a borrower, for from 
the competition between banks of which he can 
always avail himself, a borrower can assure him- 

: of the best treatment, often better treatment 
than lie d One of the banks of a bor- 

rower in the open market should be a well known 

y bank, for he should bo vouched for, if he 
h in the country, by what a lender may be sure 
i- an expert banker a- wo]] as by at least two 
bankers in hi- own town, who arc specialists so 
far a- a knowledge of the borrower's condition ls 
concerned. The city banker has a little broader 
view than the country banker, a- a rule, and his 
jmL should a be considered in matters 

general finance. Moreover, local hank- are apt 



100 COMMERCIAL PAPER 

to be over loyal to their own, and the chance for 
error in this direction should be reduced as much 
as possible. We are told to beware of the man 
of one book. For the same reason one hank check- 
ing is insufficient. A borrower should have at 
least two bankers to vouch for him, hence the rule 
that if he is in a city he should have two city 
banks to call his own. 

Great care should be taken to recheck borrowers 
through their own banks each time paper is 
bought, even if checkings have been got only six 
or four months previously. Conditions turn 
quickly and four months is long enough for a 
position to change considerably. 

The Person Offering Paper Should do 
Most of the Detail Work of Investi- 
gation, Presenting his Eesults 
With the Offering. 

It may seem as if so much investigation as is 
here called for is almost prohibitive for busy 
buyers of paper. The note broker or person offer- 
ing the paper should be obliged to present proofs 
of his recent investigations along the lines laid 
down when he offers his notes. If he is reliable 
his statement of investigation will be true and 
the lender can tell in a few glances if all is as it 
should be. It is better, of course, for the lender 
to make his individual investigations, but it should 
not be essential for him to do so. He should 
demand, however, that the investigation be made 






THE SELECTION OF COMMERCIAL PAPER 101 

and the proper condition be found by others if not 
by himself. 

(j) Make sure that at least two banks compe- 
tent to judge of the credit in question and other 
than the banks which have the account of the bor- 
rower pass favorably on the credit of the borrower. 

Too often banks which have the account of a 
borrower, when asked regarding the condition of 
that borrower, for fear of losing the account, state 
that the borrower is good when really they know 
that he is stretching his credit beyond the point 
he should. For this reason, though if a bor- 
rower's own banks pass unfavorably on his credit, 
it is enough at once to justify denial of credit by 
outsiders, if they pass favorably on his credit it 
is not necessarily enough to prove him worthy of 
outside credit. The opinion of disinterested 
hank- having knowledge of the situation should 
ho obtained. This is the best possible checking 
that can he got and it should never be neglected. 
A composite checking which shall he wholly satis- 
factory is essential. 

<k> Where trade references can be easily ob- 
tained, at least four of these, not over six months 
old, should be found to be satisfactory. 

Many firms such as wool merchants, can hardly 

>ply trade references, but all manufacturers 

who buy raw materials from other dealers can 

ich and should do so. The i rade references 

looked up and the four showing the 

largest dealings should prove thai discounts are 



102 COMMERCIAL PAPER 

taken advantage of and that the borrower is in 
good repute with these four dealers. Under the 
present system of discounting paper, which pro- 
vides cash for the buyer of raw materials at once, 
there is no reason why expensive interest rates 
should not be avoided when discounts are avail- 
able. If they are not taken, the borrower is not 
running his business properly or is not entitled 
to credit from others than those who can watch 
him closely. Owing to the rapidity with which 
positions can change, these trade references should 
not be over six months old. Four of them is 
taken as a proper number to ask for as this is 
sufficient to show conditions clearly, and as prob- 
ably most buyers of raw materials confine their 
chief purchases to about four dealers in these raw 
materials. 

(1) Make sure that insurance is carried on all 
merchandise carried. 

When a bank or individual lends against real 
estate, not only does the lender secure a mortgage 
against that real estate, but he retains fire insur- 
ance policies covering the real estate mortgaged 
up to its full value. A lender on real estate 
would be considered very lax if he did not demand 
such policies. The case is very similar with com- 
mercial paper. Collateral is not required to be 
given with the paper, but it must exist just the 
same; and if the need for it is there the need is 
there also for insurance covering it exactly as in 
the case of loans on real estate. Few lenders on 



THE SELECTION OF OOMMERC 1AL PAPEK 103 

oommercial paper pay attention to this factor in 
the situation back of the aotes they take. All 
should do s<>, for it is a very important elemenl 
in their security. Some arrangement for blanket 
insurance covering the full line of merchandise 
carried should be shown by all borrowers through 
commercial paper. 

(m> Secure as many endorsements of respon- 
sible men interested in the company borrowing as 
is possible. 

Endorsements, even if they do not bring much 
financial strength, should insure a moral hacking 
which all notes ought to have. With corporate 
lack of responsibility occasionally, at least, cur- 
rent, it is well to make 1 sure that individual respon- 
sibility is fixed. If responsibility is fixed on 
individuals, even if they have no great moan-, 
they arc much more careful to protect interests 
in which they ore associated than if their names 
not a [>i>< ar in the matter. 

('arc should be taken, however., never to buy a 
note because of an endorser only. Endorsements 
arc usually weak ties between borrower and Lender. 
It' a uote does nol appear sound without an 
endorser, it should he discarded, even if a strong 
name is put on. Lend to the endorser direct 
rather than in this form. 

<n The rate for the paper should be satisfac- 
tory. 

I hi- i- the lasl aid least important rule for 
the purchas tnmercial paper. Safety should 



104 COMMERCIAL PAPER 

always come first, and the best buyers of paper 
will always have this first in mind, with rate as 
a secondary consideration. A very large number 
of paper buyers ask immediately on the offering 
of notes for discount if the rate is say 5% when 
the market varies from 4-1/2% to 5%, and refuse 
to consider the paper unless it bears the top rate, 
taking weaker notes in its place at 5%. This 
is an absolutely wrong method to pursue. The 
best is none too good ; and in finance, where safety 
of the principal must necessarily be the chief aim 
of an investor, this is an especially apt rule to 
follow. Commercial paper can often enough be 
traded in as to rate and usually it is worth while 
in buying paper to try to trade somewhat on rate ; 
but it is essential to good banking and finance that 
the purchases of paper shall finally be made from 
the best paper available bearing the market rate, 
the market rate being determined by the offerings 
of all paper coming from reliable sources. The 
market rate will usually vary from one-half to 
three-quarters of one per cent. 

Large Borrowers Have to Pay 
a High Rate. 

Oftentimes a note offered for discount at 4-3/4 
when the market rate is 4-1/4 to 5% will be fully 
as strong as those offered at 4-1/4. The price of 
commercial paper is not necessarily a criterion of 
worth. Price being a resultant of demand and 
supply it readily appears that certain notes, the 



THE SELECTION OF COMMERCIAL PAPER 105 

promisors on which are not well known and yet 
who are strong and make a good showing, will at 
times have to carry a somewhat higher rate of 
interest re invite purchasers than will paper the 
worth of which is widely known. Moreover, Large 
borrowers, owing to the practice of diversified 
investment, have to make their borrowings at- 
tractive to a very large number of lenders. Hence 
they arc forced to put a rate on their paper which 
will carry it broadcast, although the borrowers 
themselves may be of the strongest son and 
although if they wished to borrow say $50,000 

stead of $1,000,000 they might be able to find 
a lender who would discount their paper at a 
considerably lower rate than the lender gets on 
the basis of the larger offering. Kate is often 
taken as an exact representation of strength, and 

comparison of rates is made to compare relative 
_ "h. This is often exceedingly fallacious and 
not by any means be set down as an absolute 
to follow. 

City Banks Do Not Get as High Rates 
as Country Banks. 

City banks are but intermittent lenders in the 
open market. They have to care for the large 

serves of the country and they have compar- 
ely few funds on which they can depend for 

ady buying of paper. A- the nature of the 
business of all of them is similar, when they do 
buy they buy nearly together and in large quan- 



106 COMMERCIAL PAPER 

tities. Their position to trade for rates is there- 
fore weakened, and as a consequence city hanks 
rarely obtain as high a rate on the paper they buy 
as individuals or country banks do. They cannot 
expect to. Often the market rate in the city and 
in the country will vary from 1/4% to 1/2%. 
It should not vary over this, nor should banks 
outside the centres expect it to. On the other 
hand, country banks should remember that they 
are entitled to a rate slightly above the market and 
should not be bashful in asking for it. 

Borrowers Should Not Expect Maximum 
or Minimum Rates at Their 
Own Banks. 

Borrowers who discount with their own banks 
must realize that these banks are bound to stand 
by them at all times, and consequently should not 
expect the minimum any more than they should 
the maximum rate that trading in commercial 
paper brings in times of ease or of stress. What 
borrowers at their own banks most need is a 
dependable and non-fluctuating market for money 
for their requirements, and such a market entails 
steady interest rates. If it is not fair for a bank 
to charge the maximum rate during a panic to 
its own customers, neither is it fair for the cus- 
tomer to expect the minimum rate in times of very 
easy money. 



THE SELECTION OF COMMERCIAL PAPER 107 

Low Kates should not Stop the 
Buying of Commercial Paper. 

When mon a - . it is a great question for 

many banks and investors whether or not to buy 
mmercial paper or longer time securities bear- 
ing a higher rare. Bankers who are not students 

fundamental conditio] - n make th< g 

error of buying long term bonds at such tin 

- however, who study fundamental eru- 
ditions and the Composite Plot siness I !on- 
ditions prefer always to keep a large amount 
liquid or semi-liquid capital l»ii hand. For them 
it usually seems bes ay commercial paper, not 

•ur months in length, if n. s sy, 

rather than t<:» gamble on being able to realize on 

the longer term securities bearing tin- higher rate 

in - need comes to liquidate them. Call 

in times of v is next t<> 

— - an earner of interest Four monl a 
pap - a rule bears nearly as high a i 

months -. ( onditions are apt t«> 

turn suddenly. B it i- that four monl a 

named - - desirable form of 

inv - in til:. J of g 

When I '«»!i in iei vial Paper Pate- Are High 

Tlierr Are Often Greater Bargains in 

Other Fields Than That of Com- 

mercial Paper. 

^ !.• _ in tim« - anic, in 

itive rates many in -urn from 



108 COMMERCIAL PAPER 

commercial paper to convertible bonds and high 
grade investment stocks. Such investments even 
by investors, who as a rule need to put their 
money into short time commercial paper, are very 
often justified. For those who have been buying 
commercial paper in the hope of securing bargains 
in the investment field this is apt to be the oppor- 
tunity for which they have been looking, as it is 
usually in such times that bargains occur. One 
of the chief advantages of good commercial paper 
as an investment to many is that it puts them in 
a position to accept such chances as these, as it 
ensures them with a supply of ready money every 
few months, however great the crisis. 

Discount Should be Figured by Days. 

In the discounting of commercial paper, buyers 
should discount by days and not by months and 
days. Up to a few years ago both systems were 
generally in practice in this country, but now it 
is the general practice of all dealers in commercial 
paper to discount by days alone, that is, if the 
paper has a month or more to run, to figure the 
actual number of days instead of calling a month 
thirty days, as is done in figuring bond interest. 
There is no law compelling the figuring of dis- 
count by days other than the unwritten law known 
by the banks and in force because practiced by 
the majority of them; but it is the general custom 
among the big buyers of paper and should be 
adopted by all for the sake of uniformity if for 



THE SELECTION OF COMMERCIAL FAFER 109 

no other reason. The system of discounting by 
dav> is, of course, obviously to the advantage of the 
Lender ever the system of charging interest by 

months and days, thirty days to. the month, as 

it allows a few extra days interest in the course 
of a year. 



CHAPTER IV 

THE ANALYSIS OF A FINANCIAL STATEMENT 
AND KEPOKT 

A FINANCIAL REPORT consists of two 
parts, a statement of the assets and the 
liabilities and a report for at least the 
period of a year of the earnings and the expenses. 
The value of a property being largely dependent 
on its earning capacity, no financial report is 
complete without a representation of both of these 
items. Mills, stores and supplies of merchandise 
can, of course, be sold either for like use by others 
or for purposes other than those for which they 
have been used. For the purpose of representing 
financial condition in respect to these items, a 
statement of assets and liabilities alone will suffice 
and is all that is often given. Such a statement 
is not sufficient, however, if the true condition of 
any company as it exists is to be found. 

A Financial Statement Should Appear 
in its Simplest Form. 

The statement of assets and liabilities should 
be a trial balance of the books of the company 
after all accounts have been reduced to their 
simplest form. A trial balance showing many 
items which should, for instance, be charged to 
profit and loss is not in clear form. The inves- 
tigator should analyze all general items on a state- 
ment and should be aware at least of their general 



ANALYSIS OF FIXAXCIAL STATEMENT 111 

make up; but this work of analysis should be a 
study separated from that of a review of the gen- 
eral financial condition of the company. It should 
be a subdivision of this work. The first regard 
of a student of the finances of a company should 
be tor totals on the asset and on the liability side 
of a statement which are properly to be contrasted. 
For this reason ho should not be forced to examine 
minor items on the asset side, for instance, which 
he will ultimately have to charge to the liability 
side, or vice versa. lie should demand that the 
statement lie is to examine be presented in its 
simplest form with an explanation of its items set 
down elsewhere. If it cannot be so presented, it 
should be his first duty to place all items under 
their proper general headings. 

The Usefulness of a Statement is in 
its Representation of Contrast. 

In any statement of as-ets and liabilities, the 
assets should he entirely by themselves and the 
Liabilities entirely by themselves. The usefulness 
of a statement i- in it- representation of contrast. 
If. for instance, the assets are arranged, a- often 
happens, a- follow-, a poor form of statement 
results. 



ASSETS 




LIABILITIES 


Fixed assets 


$60,000 


Capital account $40,000 


. 


20,000 

.-HI.) 




Otbei 


10.0(H) 





112 COMMERCIAL PAPER 

The mortgage should appear among the liabil- 
ities, so that at a glance an observer can see that 
the total money put in the business is $60,000, 
which is represented by $60,000 of property. The 
other form of statement, as exhibited, shows the 
situation ; but it does not set it forth clearly and it 
does not show the margin of safety. It does not 
show at a glance that there are $60,000 for which 
the assets are liable. In the case of a statement 
at all confused by many items, it may take a care- 
ful review to diagnose properly the situation. A 
careless observer might pass over the mortgage, the 
most important item, altogether. The first thing, 
therefore, for the analyzer of a financial statement 
to do is to make clear to himself exactly what are 
the liabilities and their nature, and the assets and 
their nature. 

The Form of Statements Must 
Necessarily Differ. 

Statements of assets and liabilities vary in their 
form according to adaptability of the form for 
showing the financial condition of any particular 
company. A mercantile company should show its 
assets and liabilities carefully grouped to represent 
fixed assets and quick or current assets. Opposite 
them it should show, first, capital and surplus 
accounts and mortgage account, then all other 
liabilities which are to be contrasted with the cur- 
rent or quick assets. Current or quick assets are 
those which are necessarily to care for the liabil- 



ANALYSIS OV FINANCIAL STATEMENT 113 

ities already maturing or about to mature. A 
mortgage having some time to run, or funded debt 
of any form which may be classed in a statement 
with a mortgage, look to the fixed assets or the 
credit they allow for their liquidation. A mort- 
al ge or funded debt should show its maturity on 
the statement, s<> that the observer may judge from 
the nature of the fixed assets whether they are 
likely to retain their value to the maturity of the 
funded indebtedness. A proper form for the 
3sets and liabilities of a company engaged in a 
mercantile business is as follows: 

ASSETS LIABILITIES 

Real Estate . $25,000 Capital . . . $100,000 

Buildings . . 40.000 Surplus . . . 40.000 

Machinery . . 30.000 Mortgage (1920) 30.000 

- $95,000 Aocts. payable 25.000 

Accounts Rec. $60,000 Bills payable . o.OOO 

Stock on Eland 35,000 

Gash . . . 10.000 $200,000 
105,000 



$200,000 

From a statement such as this the observer can 
tell that there is a mortgage of $30,000, not matur- 
ing for some years, covered by $95,000, and hav- 
ing, evidently, a fair margin of safety behind it 
if the fixed assets represent real worth. He can 
- i tell readily that the debl for which the 
company is immediately responsible amounts to 
hich is covered by $105,000 due the 
company very soon or in hand. 



114 COMMERCIAL PAPER 

Liabilities Should be Examined First. 

In the analysis of the statement of a mercantile 
company the assets and the liabilities should be 
arranged, at least in the reader's mind, in some 
such order as appears in the foregoing. The lia- 
bilities are the most important and should be 
looked at first. Primarily should come the amount 
of capital that has presumably been put in the 
company by those interested. The best form for 
this item to appear in is, if the case in hand is a 
partnership, as follows : 

Capital $100,000 
(Representing cash) 

or if the case in hand is that of a corporation, as 
follows : 

Capital stock 

Pfd. stock . . $50,000 

all paid in 

Common stock . 50,000 

all paid in 

$100,000 

It Should be Known How Much Cash 
the Capital Item Represents. 

It is a very important matter to find out how 
much real money the capital item represents. 
Many corporations include in their capital account 
a considerable amount of "water" stock and mark 
up their real estate and machinery on their asset 
side, or fill in with patents, good will, etc., to 



ANALYSIS OF FINANCIAL STATEMENT 115 

equalize. If money has really passed for these 
patents and good will, they arc probably of value 
an<l have some right to appear in the assets. Tf 
no money has passed for them, their value, which 
is problematical at best, lias usually uo right to 
representation on the statement. The safest form 
of statement and the one most likely to inspire the 
reviewer with confidence is one that does not 
include patents and good will at all, or that marks 
them off a- soon a- possible and that states the 
amount of money that has actually been put in 
the business. This should not necessarily pre- 
clude the introduction of "water" stock, for it is 
possible to offset stock that clearly is water by an 
item such a- "common -toek possibilities." Stock 
watering i- not necessarily an evil. Men who risk 
much may deserve exceptional profits and for the 
benefits of business it often occurs that these prob- 
lematical profits should he represented by certain 
irities other than those representing real dollars 
and cents. Often too, it i- desirable to spread div- 
idend- over a large area rather than to pay high 
dividend- on a -mall amount of capital stock. The 
capitalization of a surplus or a large earning 
capacity on a -mall dividend basis is very often a 
worthy end. The situation, however, should be 
made clear ami m»t disguised a- it i- in mosl state- 
ments of financial condition today. The real 
situation is the one to he discovered; and if ii is 
not clear in the statement, a true explanation 
of the situation should be demanded at once. 



116 COMMERCIAL PAPER 

The Money Equivalent of the Stock 
Item Should be Known. 

Sometimes stock, even preferred stock, is sold 
below or above par and represents less or more 
than its book value. If the company has a surplus, 
any premium for the stock should be shown in the 
surplus ; and if the company has not a surplus, any 
deficit in the sale of stock from its par value should 
appear in a profit and loss item on the asset side. 
The analyzer of a financial statement should assure 
himself that the real money equivalent of the 
capital stock item is represented on the statement 
under consideration. 

The Surplus Item Should Eeceive Very 
Careful Consideration. 

With the capital item should be considered the 
surplus item where any such exists. The surplus 
should represent real money gain on the part of 
the company which has been left in the company. 
Surplus account is the margin of safety of the 
capital account. A large surplus account shows 
a history of conservative policy on the part of the 
managers of a company and also success over an 
extended period. It represents also a resource for 
times of need. A surplus should be looked for on 
any financial statement, the larger the better. 
Where no surplus item exists, inquiry into the 
causes for its non-appearance should be begun at 
once. 



ANALYSIS OF FINANCIAL STATEMENT 117 

The Surplus I torn is to be Analyzed. 

The surplus item may represent several things. 
It may represent simply net gain which is in the 
form of undivided profits, and profits which might 
fairly be capitalized. It may represent a reserve 

account for future risks, in which case it cannot 
fairly be capitalized. It may represent a depre- 
ciation account for real estate, buildings, ma- 
chinery, or a sinking fund for the retirement of 
debt. Any analyzer of a financial statement 
Bhould satisfy himself as to which class the surplus 
item belongs. Properly, the surplus should show 
on its face the kind of surplus it i>. A deprecia- 
tion reserve is very different from a surplus ready 
for capitalization and properly it should he entered 
n<»r as surplus but as a depreciation charge. 

The Book Value of Fixed Assets Must 
be Carefully Studied. 

Land, buildings and machinery may depreciate 
fast. If they are not marked down at proper 
intervals, a depreciation account should offset their 
loss in value or need for repairs. The analyzer 
3tatemen1 must assure himself at once thai 
all fixed assets are carried at not exceeding their 
present value. If they are carried at cost, when 
they have gone oil" in value or are likely t<> in the 
near future, a proper liability charge should be 
made t<. insure the company up t<» the amount of 
the loss in value. Fixed assets should never he 



118 COMMERCIAL PAPER 

carried above cost. To do so confuses the situa- 
tion immediately and nullifies the usefulness of 
any financial statement. 

Properly a capital and surplus account should 
read as follows : — 

Eeal property $50,000 Capital $50,000 
(Cost price) 

Where the cost price is equal to the pres- 
ent valuation 
or 

Real property $40,000 Capital $50,000 
Where the present valuation is less than 
the cost price 
Profit and 

Loss 10,000 

$50,000 

The Profit and Loss item on the asset side may 
be deducted from surplus account to an equal 
amount when sufficient surplus exists on the lia- 
bility side. 

In case the property has increased in value, the 
following form is recommended. 



Land .... 


$50,000 


Capital .... $75,000 


(Cost price) 




Surplus .... 5,000 


Increase in value . 


10,000 


Depreciation ac- 


Building, built 1908, 




count .... 5,000 


cost .... 


25,000 


Mortgage due 1920 15,000 


Machinery, new 


15,000 




cost 


$100,000 



$100,000 



ANALYSIS OF FINANCIAL STATEMENT 119 

The Purpose of any Depreciation 
Fund Should Appear. 

Depreciation may exist to pay off the mortgage 
or to offset decreasing value in the building and 

machinery. If new property is bought, or the 
old repaired with the depreciation fund, it is to 
be presumed that when the mortgage comes due 
it can be renewed on the same terms as those on 
which it was originally placed. To maintain 
value of property is usually better than to have 
the mortgage paid by the depreciation fund and 
to have the usefulness of the machinery and build- 
ings exhausted. The reviewer of a statement 
must make up his mind what a fair depreciation 
and reserve account is under the conditions ex- 
hibited and look for such accounts either by them- 
selves, which is where they should be, or in the 
Burplus item. 

Statements for Several Years Back 
Should be Compared. 

Comparison of statements, if possible over a 
term of years and always for al leasl a year, 
should be made in any investigation of the finances 
of ;i company. This should be made with especial 
reference to surplus account. It' a loss is shown, 
inquiry should Ik- made regarding it. A com- 
parison of financial reports should show ;i- well 
;i- the difference in surplus accounts any difference 
there mav be in volume of business being done 



120 COMMERCIAL PAPER, 

and in profit. Besides the surplus item, com- 
parison should be made from the statements, 
especially of notes payable, notes receivable, and 
merchandise items. If marked disparity occurs, 
inquiry should be made regarding the causes. 

Any Long Time Debt Item Ought to 
Show the Maturity of the Debt. 

Turning back after consideration of the surplus 
item to the simple statement already shown, the 
analyzer finds that mortgage or long time debt 
account, if any exists, is next to be considered. 
This, as has been stated, should show its maturity, 
and should be at once compared with the permanent 
assets of the company, due consideration being 
given to the reserve account offsetting any likely 
depreciation in connection with them. 

Any Funded Debt Should Have a Large 
Margin of Safety. 

If the long time debt in the form of mortgage 
or other funded debt matures within a compara- 
tively short time, the analyzer of the statement, 
before he can pass on it as satisfactory, should 
assure himself that new financing for the refund- 
ing of this debt is already accomplished, that it 
is likely to be, or else that the assets of the com- 
pany are sufficient at a forced sale to liquidate the 
mortgage debt and leave a sufficient balance for 
his purposes. If the long time debt does not 



ANALYSIS OV FINANCIAL STATEMENT 121 

mature for a considerable period, he may be satis- 
tied if rlic permanent assets afford a fair margin 
of safety for the mortgage debt, and if what he 
feels is a fair depreciation account is being main- 
tained. 

Capitalistic Accounts are to be Kept 
Distinct From Other Items. 

By -"mo writers bonded debt is regarded as 
capital. It is hardly to he so regarded if an exact 
representation of financial conditions is required. 
landed Debt or long time debt i> distinctly, how- 
ever, to be grouped with Capital and Surplus 
accounts. These three items are to be considered 
a- "capitalistic" accounts, or as accounts pertaining 
to capital, and they must necessarily he considered 
gether and as a whole, apart from other liabilities 
of the company under examination. They are 
each of them, however, distinct. Grouped with 
them at times may he such item- a- [nsurance 
account, when the company carries its own tire or 
health insurance, Depreciation, Reserve, etc. 

Funded Debt Should be Protected 
by Fixed Assets. 

Long time debt accounts are contrasted with 
quick assets only a- a rule when the company in 
question ha- had greal success and ha- built up a 
large working capital. It must be remembered 
that the liabiliites of a company form the mbsl 



122 COMMERCIAL PAPER 

important factor in connection with it. The larger 
margin of safety over any debt, the better. Hence 
quick assets are looked to as being -usually only 
enough to protect current liabilities. The perma- 
nent assets should in themselves protect capital- 
istic accounts. Having made up his mind regard- 
ing the situation of the capitalistic accounts, and 
having compared them roughly with the perma- 
nent assets, the examiner should review carefully 
all permanent asset items. He should satisfy 
himself that the value of the land as shown by the 
statement is close at least to its assessed valuation. 
He should assure himself that the buildings have 
been appraised by a competent judge and that the 
opinion of that judge is expressed on the state- 
ment. He should consider the machinery, if any, 
with a view to its adaptability for its immediate 
purpose, its condition, and its being up-to-date for 
the work to which it is being put, at the same time 
applying any depreciation and reserve accounts 
there may be as has been shown. 

Earnings Should be Examined Carefully. 

Having contrasted carefully the permanent or 
fixed assets of a company and its capitalistic 
accounts, the examiner should glance at the recent 
earnings of the company. If the earnings appear 
to be good and the comparison he has. just made 
satisfactory, he may go on to further consideration 
of the statement at once. Small earnings, espe- 
cially where interest must be paid in any quantity, 



ANALYSIS OF FINANCIAL STATEMENT 123 

should be taken as a danger signal at once; and it' 
the examiner is at all hurried he should inquire 
immediately into the condition of the earning 
capacity of the company. If earnings arc satis- 
factory, however, or where they are not, it' he 
wishes to complete his study of the statement, he 
should now go on with the items making up cur- 
rent liabilities. 

The most common current liabilities consist of 

Bills payable 

Accounts or notes payable 

Reserve for had debts 

Deposit accounts 

Accrued taxes 

Wage items 

Interest accrued 

Xotes on demand 

Rent 
and similar items. 

The Bills Payable Item Should 
be Kept Down. 

Bills payable Bhould be small. Every com- 
pany should keep its small charges well paid up. 
In this item should come such charges as running 
expenses other than salaries and rem. Mfosl of 
the factors making up this aggregate will be small 
and it is an expression of a well run business it' 
they are taken care of as they come in and are 
Dot allowed to accumulate, especially at the time 
for putting out a statement. It shows careless- 



124 COMMERCIAL PAPER 

ness, lack of resource and lax methods where a 
large accumulation of bills payable exists. 

Great Emphasis Should be Laid on the 
Study of the Notes Payable Item. 

Notes payable should include commercial paper 
only. Of course, the smaller this item is, the 
better for the company. If the amount is large 
the examiner should make sure that the notes are 
not renewals of old debts, as if they are they are 
apt to show -an unhealthy condition, as has been 
stated in the Chapter on the Selection of Com- 
mercial Paper. When possible, notes payable 
should be divided so as to shoiv the amounts of 
notes payable to the banks of the company and 
those notes placed in the general market. Notes 
which are payable to the banks of a company, are 
not as much a danger in themselves as those placed 
in the open market, since they are more likely to 
be renewed without trouble in case the need arises. 
Their existence limits borrowing ability, however, 
and the best condition for a company, where a 
floating debt is essential, is to have the company 
owe its banks nothing, as in this case it can go 
to them for assistance, if occasion arises requiring 
special aid. The floating debt of a company is 
its greatest source of danger, and an investigator 
of the affairs of a company can hardly pay too 
much attention to it. The study of the notes pay- 
able item should be taken in conjunction with a 
consideration of general business conditions and 



ANALYSIS OF FINANCIAL STATEMENT 125 

of the business needs of the company under inves- 
tigation. The student should make up his mind 
from his knowledge of conditions what a fair 
amount of notes payable should be and he should 
compare this amount with the volume shown on 
the statement. If the amount seems over large 
as given he should at once satisfy himself as to 
thr causes. 

It Should Appear Whether or not Notes 
Payable are Given for Merchandise. 

Notes or accounts payable may be given directly 
for merchandise. Enquiry should he made whether 
they are or are not ><» given. If they are so given 
and they are large, the volume is apt to indicate 
that merchandise discounts are not taken advan- 
tage of. A large volume of notes or accounts 
payable where such are given for merchandise 
bought some time previously expresses at once an 
unhealthy condition, and again is apt to -how lax 
business methods. It, at any rate, is a danger 

aal. With a large amount of notes or accounts 

payable given directly for merchandise, inquiry 

should be made at once when the notes were given 

and why they have not been paid. This large 

amount may be a proper one, but it is nol usually 

Enquiry should be made in a study of the 

- and accounts payable item if any of the 

tea and accounts payable arc secured, thai is, 

it' any form of collateral is given with them. If 

collateral is given for all, the giving of it may be 



126 COMMERCIAL PAPER 

an entirely proper matter. This is for the inves- 
tigator to decide. But where, as very often hap- 
pens, collateral is given for some and not for 
others, a great source of danger may exist for the 
unsecured creditors. It is a matter not to be 
passed over lightly. 

Notes Payable Form the Principal 
Item in Current Liabilities. 

The notes and accounts payable item in a state- 
ment will usually form the chief factor in the 
total floating debt or current liabilities. When it 
is considered, a review of the quick assets of the 
company which are supposed to care for it should 
be made as well. We have taken two and a 
quarter of quick assets to one of debt as a proper 
proportion to look for. The analyzer must be 
sure, however, that the two and a quarter, or 
whatever the sum of the quick assets shows over 
the floating debt, is a fair representation of value. 
The merchandise should never he figured above 
cost and should be put in the. statement at the 
marhet value if the value is below cost. 

The Bills Receivable Item Should be Small. 

The bills and accounts receivable item should 
as a rule be small. If it is large it is apt to show 
that the company has been forced to carry its 
customers. When this item is large, inquiry 
should be made at once regarding the cause, and if 



ANALYSIS ov FINANCIAL STATEMENT L27 

a satisfactory explanation is not given a scaling 
down of this amount should be made. The good 
standing of all customers of a company which owe 
it money should, of course, be investigated when 
making a complete examination of the financial 
affairs of any company. Perhaps a sinking fund 
or a reserve for had debts may he necessary. The 
analyzer of a mercantile statement should make 
inquiry as to the bad debts of the company for 
previous years. He should average them and if 
needed he should find a reserve for bad debts on 
the liability side of the statement or should make 
an allowance from the accounts receivable to an 
equivalent amount. 

Quick Assets Should Protect 
Floating Debt, 

Quick assets, or those to he grouped for contrast 

with floating debt, should include those only which 

can command an immediate liquidation without 

much sacrifice. Machinery cannol he figured as 

a quick asset, real estate cannol ho. patents, good 

will and stock in subsidiary corporations arc u<>i 

t<» be so considered. Timber property may or may 

n<>r he. It is dangerous to include it a- a quick 

timber property has a fairly ready 

able value and may under certain carefully 

:ted conditions be so placed. The common 

classi d us quick assi ts are merchandise, 

cash and bills and accounts receivable. 



128 COMMERCIAL PAPER 

Deposit Accounts May be Dangerous. 

Liabilities other than those already considered 
that may appear among current liabilities are 
usually minor in character. They are deposit 
accounts, accrued taxes, wages, accrued interest, 
notes on demand, rent, etc. Deposit accounts, 
unless withdrawals are prevented by a stated agree- 
ment, if they are at all large, are apt to be a source 
of danger to creditors other than the depositors. 
Depositors are apt to be those who have associa- 
tions with the company. It is these who in time 
of trouble would be the first to know of it and to 
protect themselves by withdrawing their deposits. 
In considering the relation of quick assets to float- 
ing debt it is well where a deposit account is shown 
of any size to deduct the amount of the deposits 
from the total quick assets, and then to compare 
the remaining quick assets with the current liabil- 
ities other than the deposits. Notes on demand 
should be classed as deposits. 

All Minor Liabilities Should Appear 
on a Statement. 

Accrued wages and interest and rent as well as 
unpaid insurance that is about to be due should 
appear on a statement in some form. These items 
will not as a rule total very much, but a well run 
business will have them always in mind and will 
show its preparation for them on its statement. 
Insurance is usually paid for by five year periods 



ANALYSIS OF FINANCIAL STATEMENT 129 

in advance. It is well for a company to show a 
sinking fund for renewal oi' insurance where it 
- not carry its own insurance. 

Contingent Liabilities Should Also Appear. 

ntingent liabilities such as endorsements, etc. 
are a source of grave danger to many companies. 
There should properly be no contingent liabilities. 
Where they exist their total amount should be 
ted. Their situation should be investigated and 
proper allowance made for them among the liabil- 
ities of the company. 

It is Important to Know if a Company 
is a Partnership or a Corporation. 

In consideration of any company, inquiry should 
made at first as to whether it is a partnership 
a corporation. Partnerships carry personal 
liability on the part of the partners in favor of 
the creditors of the company. Most corporations 
have no such liability. A few -rate- have arranged 
that there shall be a certain liability of stock- 
holders for debts of a corporation chartered under 
ir laws, but the value of this liability to cred- 
os is problematical and is apt to be of no very 
alue. Ir i- well, however, \'<>v an inves- 
know under the laws of what state any 
poration which he is considering is incorporated 
and iho gisl of the corporation law.- of the Mate. 



130 



COMMERCIAL PAPER 



A proper form of statement for a mercantile 
company in a full exhibit is as follows : 



ASSETS 




Land 


$50,000 




(Cost value) 






Buildings .... 


30,000 




(Built 1900) 






Machinery .... 


20,000 




(New) 




$100,000 




Cash 


15,000 




Notes and bills rec. . 


40,000 




Merchandise 


50,000 




(Cost value) 




105,000 




Stock in other cor- 






porations . 


5,000 


5,000 


(Bid price) 












$210,000 


LIABILITIES 




Capital pfd. stock 


$50,000 




(all paid in) 






Common stock 


25,000 




(all paid in) 






Surplus .... 


50,000 


$125,000 






Mortgage .... 




40,000 


(due 1920) 






Bills payable . 


3,000 




Notes payable 


35,000 




Reserve for bad debts 


2,000 




Insurance s. f. 


1,000 




Other liabilities . 


4,000 


45,000 



$210,000 



ANALYSIS OF FINANCIAL STATEMENT 131 

The company lias no contingent liabilities. 
The buildings have been marked down in 

value •].' < for each year since they were 
built. 

All accounts and bills receivable are con- 
sidered good. 

The present market value of the merchan- 
dise carried is greater than its book value. 
Full insurance on all assets is carried. 
ABC Company 

by X Y Z, Treasurer. 

All statements should be signed by a proper 

official of the company and if possible should be 

audited. Also, comparative Balance Sheets for 

is years should be submitted to show how 

the company has progressed. 

Income and Expenditure Accounts 
Ought to be Analyzed. 

With a study of the financial statement of a 
mercantile company, there should be a parallel 
Btudy of the earnings of the company for at least 
the past year. Often a statemenl of condition 
will show the net gain for six months or a year 
3eparate item. It Is well to have such an 

:i appear. Where it does no1 appear, and for 
a thorough study where it does appear, the income 

; expenditure sheets should be carefully exam- 
ined. These should show gross sales, cost of 
materials, c manufacture, cost of sales, div- 



132 COMMERCIAL PAPER 

idends, and charges to surplus or sinking fund 
accounts as well as any other receipts or payments. 
If a company owns stock in another company its 
receipts on this stock will, of course, also appear. 

A Company Should be Making at 
Least Ten Percent Net. 

If an industrial company is not showing ten 
per cent net earned on its stock, where all the stock 
represents a paid in capital, special inquiry should 
be made as to the reasons. Small earnings or 
even a loss over one or two years may mean little ; 
but such earnings over a term of years hardly 
show a strong financial condition and should 
seriously affect the judgment of the investigator 
concerning the company even where the assets and 
liabilities compare fairly favorably. A company 
exists to earn money. If it cannot earn money 
there is apt to be something radically wrong with 
it and a doubly careful study of its financial state- 
ment as a true representation of its real condition 
should be made. 

We Have Examples of Properly 
Constituted Statements. 

The annual financial report of one of the largest 
American industrial corporations gives its income 
and expenditure account first. It states clearly 
the total earnings of all properties after all regular 



ANALYSIS OF FINANCIAL BTATEMENT 133 

fixed charges for these properties have been made. 
It deducts ar once from this amount charges for 
sinking funds, depreciation and extraordinary 
replacement funds, giving the result as it- ne1 
earnings for the year. It deducts from these nel 
earnings interest on its bonds, charges arising from 
adjustment of account- and dividends, showing 
the item resulting as its Burplus not income for 
the year. The statement then deducts from this 
surplus net income special appropriations, carry- 
ing forward the remainder as a balance for un- 
divided surplus. The statement then exhibits its 
undivided surplus in full form, and explains its 
total construction. 

Net Earnings are Properly Earnings 
Applicable to Dividends. 

This statement makes a (dear distinction between 
nor earnings and surplus net earnings or those 
after interest charges and dividends. In this ease 
no unfavorable criticism can he made; but as a 
rule it is the holiof of the writers that net earnings 
should ho a term applied to the remainder only 
of all earnings after every charge ha- been made 
gainst thom that can ho called a fixed charge, 
with the exception of dividends. According to 
this rule bond interest charges should ho deducted 
before any remainder which can ho called net 
earnings can result. 



134 COMMERCIAL PAPER 

A Proper Statement Will Contrast 

Earnings and Expenditures 

Over a Term of Years. 

After exhibiting its statement of earnings and 
expenditures clearly and fully, this corporation 
has set these forth again in a comparative table 
its earnings and expenditures for the past two 
fiscal years, showing the increase or decrease in 
each item. After this, it explains fully the items 
of charges for maintenance, renewals and extra- 
ordinary replacements as well as other items for 
which charges from gross earnings have been 
made. It also gives in detail the make up of the 
items which constitute its gross earnings. The 
volume of business is also stated, as are its earn- 
ings by months and quarters for the past five years. 

In Such a Statement all Items "Will be 
Followed by Explanatory Notes. 

The statement of condition, as shown in the 
general balance sheet of the corporation, gives in 
clear form under distinct headings and with sub- 
divisions under each heading the usual items of 
assets and liabilities that have been described with 
some few additions to suit the especial needs of 
the said corporation. All items are explained in 
full in a separate review of these items. Especial 
stress is laid in explaining the make up of the 
item of inventory of merchandise. The entire 
statement of the general balance sheet and of earn- 
ings and expenditures is signed by auditors as 



ANALYSIS OF FINANCIAL STATEMENT 135 

being in their opinion a fair representation of 
condition. 

A True Statement Will State AH the Facts. 

Such a report may be taken as an excellent 
example of what a full and clear report of any 
company should be. What ii points out are the 
•ntial factors all reviewers of statements should 
look tor. Many mercantile companies do not care 
to make public in such detail all of the factors in 
their business condition; but if the reviewer really 

shes to analyze the financial situation of the 
company he must bring them to light. The detail 
into which a review should go depends on the need 
arrive at the exact situation. The deeper an 
examiner goes towards an accurate knowledge of 
the make up of all parts of the financial exhibit, 
the better. lie must in any case assure himself 
that he ha- the chief items among the assets and 
the liabilities clearly and separately in his mind 
and that the make up of these items is at least 
approximately correct. 

A Railroad Report is Necessarily Dif- 
ferent from the Report of an 
Industrial Corporation. 

The analysis "1' a railroad reporl presents many 
situations which do not appear in the financial 
reporl of a mercantile company or of public Service 
corporations other than railroads. Much more 
emphasis musl he placed on the earning capacity 



136 COMMERCIAL PAPER 

of a railroad in considering its financial condition 
than on the earning capacity of other companies, 
important as it is in the latter cases. A mill or 
a store or land used by a mercantile company can 
if necessary be turned to other uses than those 
to which they are momentarily put. The chief 
fixed assets of a railroad other than its rolling 
stock are of comparatively little value to anyone 
but the managers of a railroad operating as the 
railroad in question is operating. Even rolling 
stock, though it may be sold to other railroads, 
cannot be regarded in the light of merchandise 
like cloth, wool or leather. For these reasons the 
earning power of a railroad assumes the most 
important place in its financial exhibit. By earn- 
ing power, the student must include earning 
power over a considerable term of years, not for 
a short time, as earnings from such a period 
are apt to be dependent on local conditions which 
do not fairly represent the ability of the road to 
show increase. 

The Most Important Factor in a Railroad 
Report is its Statement of Earnings. 

On the earning power of a railroad depends 
primarily its credit and opportunity for placing 
bonds and stock as well as its salable value if a 
sale is in question. Maintenance of property must 
be kept up, but the reason is because on such main- 
tenance depends its ultimate earning power, not 
so that the property as property may be liquidated. 



ANALYSIS OF FINANCIAL STATEMENT L37 

A railroad excellently constructed, and built at the 
lowest possible cosl through a territory which will 
not provide enough traffic to make its operation 
pay, will have little or no value if a sale of the 
property is ever effected. Consequently, it is the 
earning power of a railroad that must fixsl claim 
the attention of an analyzer of its condition. 
After an analysis of earnings ha- been made, the 
student must satisfy himself that the property 
represents its hook value, and that it is in good 
condition for the work it has to do. He must, as 
in the ease of a mercantile company, compare its 
debt with it- assets and assure himself that a proper 
margin of safety exists, the margin of safety in 
this case being dependent Largely on the earning 
capacity <>f the road. If the road shows good earn- 
ings <-dir will he sufficient to refund its debt 
and to pay full interest charges without danger of 
foreclosure. If earnings are not good, there is 
danger of foreclosure, which is apt to mean a small 
return to stockholders and other creditors owing 
to the unsalability of railroad properties unsup- 
ported by earning power. A railroad with small 
earning power can hardly, therefore, he classed as 
in a satisfactory financial condition unless its debt 
i- also very small. 

The Total Mileage of a Railroad 

Should Appear < dearly. 

In the analysis of a railroad report it is best 
have the total mileage of the road clearly in 



138 COMMERCIAL PAPER 

mind, although this total mileage should be so 
divided as to show the amount of main track. 
Earnings for a road with a large main trackage 
which are equal only to those of a road with a 
much smaller trackage of course appear in an 
unfavorable light. For this reason, having found 
the main trackage of the road, the gross earnings, 
operating expenses, and net earnings, all per mile, 
should be ascertained. The revenue should be 
divided into earnings per ton carried per mile or 
ton-mile, and per passenger carried per mile or 
passenger-mile. The maintenance charges per 
mile, the improvements per mile and the debt per 
mile should also be set down. The cost and main- 
tenance charges for locomotives, freight cars and 
passenger cars should also be kept clearly in mind. 
If possible, opposite these figures and in parallel 
columns, similar statistics for several previous years 
should be placed, and an average taken. At any 
rate, opposite them, and in parallel columns, similar 
statistics should appear for one or more other 
standard railroads conducting as nearly the same 
sort of business as is- possible. 

With the Mileage of Railroads in Mind 

a Comparison of the Roads 

Can be Made. 

With this work done and not before, is the 
student in a position to appreciate intelligently the 
earning power of the road he is considering. He 
has reduced its earning power to simple units and 



ANALYSIS OF FINANCIAL STATEMENT L39 

be has compared them with like units. In no 

other way can he comprehend the situation scientif- 
ically. To say that a railroad is earning net after 
all charges other than interest and dividends the 
Bum of $3,500,000 and that it has a bonded debl 
of $40,000,000 is no criterion for comparison for 
investment with a railroad earning $1,000,000 
after similar charges, and having a bonded debt 
of $10,000,000 on a like interest basis. If, how- 
ever, we have given us the amount of miles of 
main track of the first road as 2,000, and of the 

lond road as 500, we have a ready basis for 
comparison. The earnings per mile in the first 

- * will be $1,750 contrasted with a debt of 
$20,000 per mile. The earnings of the second 
road will be $2,000 contrasted with a debt of 
>,000 per mile. Charges for maintenance and 
depreciation being the same and the physical 
property being in equally good condition, the 
- of income being also of like nature, it 
appears that the bond- of the second road are more 
attractive for investment. To complete the com- 
parisonj the amount of outstanding -took and the 
Belling price of that stock will have to be figured. 

No Item Should be Passed 
( )vor ( Sarelessly. 

The more units in mile- thai arc found and the 
more years than this analytical work covers among 
the item- in expenditure- and receipts, assets and 
liabilities, the better for a study through compar 



140 COMMERCIAL PAPER 

ison of the condition of the road. Among them 
must necessarily be proper allowances for sinking 
funds, rentals, interest and depreciation. A rail- 
road, having to keep absolutely to date in the 
matter of efficiency, needs much larger deprecia- 
tion and maintenance charges than does the usual 
business. Such a comparison proves only the 
value of the road per mile. It does not show the 
total value of the property in question. This must 
be ascertained through multiplying the net mile 
units by number of miles, and by valuing the ter- 
minals, rolling stock, etc. The student of a rail- 
road report must make sure that the money value 
of physical property as it appears on the statement 
is a fair valuation or that it does represent such 
when accompanied by liability items which are 
available for replacement charges. The investi- 
gator should also have an eye to the item of secur- 
ities owned and outstanding guarantees. Rail- 
roads deal in such large figures that an unprotected 
liability would probably turn out to be of great 
extent if it was worth consideration at all. No 
item should be passed over that is not thoroughly 
understood and the greatest care should be taken 
that every liability or possible liability of the rail- 
road is comprehended. 

A Proper Railroad Report Shows the 
Analysis of all Items. 

The ideal railroad report gives first the income 
account for the past two years in comparative 



ANALYSIS OF FINANCIAL STATEMENT 141 

tables showing revenue from freight, passenger and 
other transportation, and then reducing this reve- 
nue to revenue per mile. The report then gives 
operating expenses in the sub-divisiens of main- 
tenance of way and structures, maintenance of 
equipment, traffic expenses, transportation expenses 
and general expenses, showing the total and reduc- 
ing them to expenses per mile. Other items going 
to make up the summary of receipts and expens 
are also shown. Each item in the entire report 
- far given is analyzed in explanatory notes, the 
ton-mile and the passenger-mile units being clearly 
shown. The equipment is described in full with 
the charges for depreciation on this equipment. 
Explanation in full is also given of the items on 
the genera] balance sheet, and such contingent lia- 
bilities as exist. All of the more important items 
are contrasted with similar items on the general 
balance sheet of the previous year. 

A Financial Report if Properly Framed 
Will Prove Conditions. 

Financial reports if they are correcl and prop- 
erly framed exhibit clearly and immediately the 
dition of a company. Bookkeeping methods 
they exist are ample to show the condition of 
any property. Conformity to simple elements of 
bookkeeping and the use of them in Bhowing the 
application of proper finance will usually be suffi- 
for <-vcn an exacting student. Crude book- 
ping, however, or lack of bookkeeping where 



142 COMMERCIAL PAPER 

bookkeeping should evidently exist, will arouse 
suspicion on the part of an investigator at once 
and may cause a more rigid examination and 
harsher demands than the case really warrants. 
The art of proper finance and the expression of 
that finance in financial reports will always make 
for the benefit of the company in question. The 
sick man who does not take proper care of himself 
and who covers up his disease may pass muster 
with his fellows for a time, but he is sure to 
suffer by it in the end and the moment he marches 
into line for examination by a competent physi- 
cian he is discovered at once and is often roughly 
treated for his attempt at deceit. Health and 
finance are very similar, and this suggestion is 
given for the benefit of both borrower and lender. 



CHAPTEE V 

BANKING 

BANKS have been among the chief factors 
in the industrial and social progress of the 
world during recent centuries and on their 
strength lias depended largely the ultimate success 
of those making use of them. Every community 
of men has had a certain amount of prosperity, 
and in an early stage of this prosperity every com- 
munity has found a need for some storage place 
for the expression of this prosperity to draw on 

desire or necessity arose. It became evident 

early that those who were best able to avoid 

famine soon gained distinct advantage over rival 

oples. In the case of the early races, therefore, 

the storage place that was needed was one for 

'1. for these peoples soon found that it was to 
their groat advantage to save their surplus food 
supply for time- when such could nol readily be 
obtained. Later, money or it- equivalenl which 
could draw food or munitions of war or whatever 

g desired from other nations was stored. The 

age place either for surplus food supply or 
\<>r money or the like was a hank, a word derived 
from the [talian word 'Tbanca," meaning a bench 
and coming probably from the old German word 
"banch," used a- referring to ;i store of goods ami 
meaning mound 3 second a bench or seat. 



144 COMMERCIAL PAPER 

Wealth has a Complex Meaning. 

All that any nation or people has to maintain 
it in its own particular standard of prosperity or 
well being we may call its wealth. The word 
wealth is derived from the Anglo-Saxon word 
"weal/' and back of that "wella," meaning well 
being. Wealth is properly that part of the eco- 
nomic resources of any given district that make 
for the well being of that district. Often what 
has been a real advantage to a race or people 
later becomes the undoing of that people. When 
this last state arises what is injurious is wealth 
no longer, yet it is not till the injury is long done, 
till a perspective has been obtained, that this 
condition can be recognized. It is only natural, 
as is the case, that the resources of a community, 
which are what men desire and are what appar- 
ently form the basis for sustaining life and a 
reserve to fall back on in hard times, should be 
regarded as a whole as wealth. The drowning 
man who clings to his gold is hindered by it, yet 
he regards it as his most valued possession. We 
have come therefore to consider wealth those 
things which the majority of men wish to possess. 
So long as the wish to live and to sustain the life 
of those we care for is the foremost strain in man- 
kind, the wealth of a people can never be far from 
those factors in its environment which go to main- 
tain its existence. In its full sense, however, 
wealth must include character and righteousness 
as well as money and property. 



BANKING 145 

Wealth is the Foundation of Progress. 

Most races which have lasted for any time have, 

by the passing down of an increasing knowledge 

and thrift, gradually increased their Btore of 

wealth. With this increasing supply to fall back 

on in time of need or to swing in the direction of 

new opportunity, their success and wealth have 

rapidly compounded, the results being largely 

adent on the original supply. It was the 

men who had this surplus, that built the first 

kingdoms of the world. In themselves, 

r or their strength or education, they were 

• tter as a rule than those they conquered or 

who died leaving their lands and their stores to 

the living. The greater strength or intelligence 

or opportunity of the victors was owing to their 

greater wealth, a wealth which at first consisted 

supply, later of munitions of war or their 

equivalent. Later still, wealth assumed a more 

complicated complexion, for as wars decreased the 

for the hand- of men enlarged and with it 

desires. Wealth then consisted of a varied 

tment of factors in men'- lives, all of which 

Beemed desirable and all of which made it easier 

them to live, increased their comforl <>r gave 

them pleasure. 

Wealth and Available Wealth are 
not the Same. 

The part of the wealth of any community which 
that body car put aside for emergency or turn 



146 COMMERCIAL PAPER 

towards new opportunity is its surplus or avail- 
able wealth. What one man might think he could 
put aside another might not, however, so we have 
to say that the amount of wealth which is avail- 
able wealth is governed by the total wealth of the 
group under consideration and by the manner of 
living of that group. The available wealth of a 
man or of a nation is that part of the total wealth 
which is over and above the part needed to sus- 
tain life and to maintain it at any set standard. 

In Protecting Wealth Banks Assume 
a Most Important Duty. 

It has been the banks from the first that have 
been the principal custodians of available wealth. 
As it has been the use of this available wealth at the 
proper time that has been one of the chief instru- 
ments in the progress of mankind, so it has been 
the efficiency of banks in preserving this wealth 
entrusted to them that has permitted the progress 
when attempted. Banks today, as they always have 
been, are the most important of public servants. 
In their protection of available wealth they per- 
form the greatest of benefits to their community. 
If they ever fail in their protection they injure 
their community probably to a greater degree than 
can any other instrument. 

The First Bankers Were the Bomans. 

The first bankers in the present day sense were 
Bomans. The varied coins which poured into 



BANKING 147 

Rome from the conquered provinces brought a 
need for money changers. This profession of 
men quickly came to the front. They at firsi 
changed money merely, bul Later took money on 
deposit having deposits of two kinds, one on which 
they paid interest, one on which they did not 

Money lias Represented Wealth for 
a Long Period. 

The coincidence of money and wealth was 

I at an early date. As ownership of wealth 
was almost always individual and as men desired 
different things, some common ground for the 
of property was necessary. This was 
found through the medium of money, a word 
ferring properly to metal coins only, but broaden- 
ing quickly to include whatever was used to effect 
_ - of property or to reckon values. Aris- 
3ays "We call wealth all things whose value 
can be measured in money." Mr. Mill, a thinker 
with somewhat greater experience in practical eco- 
nomics, voices the situation the other way by Bay- 
ing "Everything forms a part of wealth, which 
has a power of purchasing." hand, being a basic 
Ldition for life and something readily computed 
to value and desired by all, may occasionally 
be used as money. This use can occur in an 
arian community only and its occurrence is 
ss and less, for where a monetary Bystem is at 
all in keeping with the call for it a finer monetary 
based on metals has been adopted for every 



148 COMMERCIAL PAPER 

need of reckoning values or of exchange and is 
by far the simplest medium for these purposes. 

In the Middle Ages Interest was Unearned. 

An investigation into the function of banking 
should include a study of the loans made by the 
Jews in early years, for the Jews were great 
wielders of wealth. They were particularly 
thrifty and kept much by themselves, holding 
together in spite of distance between the integral 
parts of their race. The Jews managed to accu- 
mulate much of the money wealth of Europe and 
swayed their wealth with effect, showing that then 
as now money in bulk is one of the most tremen- 
dous powers men can wield for good or evil. 
Their monetary history is interesting because of 
its contrast with lending and borrowing of today. 
With the exception of the maritime cities and a 
few other cases, loans made in the middle ages 
and through the period of feudalism were used 
either for the purpose of war or for display and 
were, economically speaking, unproductive and 
without right to interest; though as a matter of 
fact interest rates were probably never higher 
than during this period. The money lenders of 
old did not part with their wealth to another even 
for a time without the expectation of gain to them- 
selves. They charged interest and at a very high 
rate. The borrowers were chiefly men of prom- 
inence whose power rested on their strength at 
arms or their display. These were their holds 



BANKING 149 

over the people and to maintain them lefl trim- for 

little els 

Interest Was Then Regarded as Qsury. 

F<>r this reason and because the borrower, if 
he were able to pay hack a loan at all was apt to 

he strong enough nor to pay. at least without a 
struggle, any consideration for the lending of 
wraith other than the return of that wealth, came 
to be regarded a- needless and beyond the law. 
It was a skillful money lender who could exact 
anything like the full tribute he demanded arid 
hitter always was the struggle between the lender 
and the borrower in those days, [nterest was 

garded as usury or illegal interest and was 
finally prohibited though probably not very suc- 

ssfully. As Mr. Pierre Des Essars says in hia 
"A History of Banking in the Latin Nations" in 
ancient days profits from the lending of money 
were considered illegitimate on the theory that 
"money is in it- very nature sterile and unpro- 
ductive." 

Banking Necessitates Individual 
Property Rights. 

Early banking broughl out one situation, as 

all banking must. It presupposed a n gnition 

ndividual property rights. Banking and prop- 

_ ts must necessarily go hand in hand. 

2 is absolutely dependent on a state of 

civilization in which the law of the ownership of 



150 COMMERCIAL PAPE& 

property is fixed and maintained. And the most 
successful banking in the history of the world has 
shown that it is the banking which facilitates the 
retention of individual property rights and does 
not retard them. 

Capital Must be Fairly Constant 
in Amount. 

We have seen that a certain portion of the 
wealth of any community is to be classified as 
available wealth because it is over and above that 
part needed to sustain life and to maintain it in 
the community at any set standard. The part of 
this available wealth which is used to create more 
wealth for the holders of it is to be known as 
capital. Capital thus becomes the active part of 
the wealth of a nation and it is for the use of 
this capital that one is justified in paying interest. 
Today it is the money in general circulation. If, 
as during certain panics, money which in this, as 
in any of the civilized countries, represents the 
wealth of that country, is withdrawn from cir- 
culation and is stored, the country is forced to 
do its ordinary business or work on a greatly 
decreased capital. If the supply is greatly de- 
creased, the machine is incapable of any creation 
and the whole work stops. The conservation of 
energy is as true in the banking as in the mechan- 
ical world. We cannot make something out of 
nothing and when, as in this country, banking is 
of such tremendous importance and so dependent 



! 



BANKING 151 

on a monetary system which will keep pace with 
the business needs which arise, it readily appears 
that we cannot progress as we should if our capital 
or monetary supply is from Time to time suddenly 
to be decreased. 

Capital is Essential for Economic 
Advancement. 

Capital is indeed the force which permits prog- 
ress, and any impulse or system which denies it 
should be frowned on or checkmated. Every aid 
to regulating properly the available supply should 
be fostered as much as possible. The miser is prop- 
erly Looked down on by his neighbors. Xo less 
dangerous, however, are those who force the pace 
of unproductive luxuries too fast. They exhaust 
or tie up the available wealth of those who could 
- this wealth to better advantage for themselves 
and for the world in general. 

When Trade Developed, Interest Became 
an Acknowledged Bight. 

Attempts have always been made on the parr 
owners of wealth to turn their wealth into 
capital. With the passing of feudalism and a 
ite of war into a more industrial era, 
opportunities to increase wealth occurred gen- 
erally, with the result thai the entire attitude of 
the world toward banking and interest changed. 
The growth of the guilds increased trade and with 



152 COMMERCIAL PAPER 

it the chance to make borrowed money earn some- 
thing. The man who borrowed money and spent 
it in unproductive pursuits was at a relative 
disadvantage. As opportunities for increasing 
wealth grew through other means than war, the 
old attitude toward interest and money lenders 
died. If the lender provided means for increas- 
ing wealth, the right was his to at least a portion 
of the return. Trade being far more consistent 
in its return than war, this portion could be more 
readily computed in advance, with the result that 
interest soon found itself on a firmer footing than 
it had ever been before, with the exception perhaps 
of the great maritime cities of Italy. And as the 
modern view of interest developed there came a 
feeling on the part of the lenders that they should 
not claim too great a share in well earned profits ; 
but should encourage trade as much as they could 
consistently, for by so doing over a term of years 
their profit would be the greater. Interest became 
an acknowledged right, but then as now too high 
an interest charge became acknowledged as harm- 
ful, both for the borrower and for the lender. 



Banks Rule Interest Rates To-day. 

Interest is a development of civilization for the 
compensating of the lender in an economically 
useful enterprise. Banks, as we have seen, are 
the chief custodians of those forces which aid 
economic progress and out of which capital can 
be made. As most capital is borrowed capital, it 



BANKING 153 

follows that it is the capital lent by the banks 
which is the chief factor in interest rates today. 

Banks Have Two Groat Duties. 

Banks have two functions to perform. They are 
depositories of the available wealth of their com- 
munity, since protection can better be given to this 
wealth in one place than in many. They have 

first, therefore, to collect as large a sum as they 
can fr<»m all. This entails their being able t<> 
collect many small amounts. Their second func- 
tion is to lend this money in productive enterprise 
by turning it into capital and to regulate the 
tension of these enterprises through their knowl- 
■:' fundamental conditions, at the same time 
arding it. 

Banks Should be Allowed to Charge 
for Their Services. 

Banks charge interest for making available 
;dth into capital (a) r<» compensate themselves 
for their trouble (b) to pay interest on the avail- 
able wealth entrusted t<> them and bo attract this 
available wealth. The men who have charge of 
turning wealth into capital have one of the mosl 
important functions in the state to perform. To 
sure that the money they lend i- do1 t<> L" 
nomically useless enterprises, but that it [g 
tain t«. return increased and within a limited 
time, n - [ knowledge, shrewdness and care. 

J be men who plan for tin'- lending deserve ruin- 



154 COMMERCIAL PAPER 

pensation and it should be large enough to keep 
the best men in charge of such work. As the 
compensation of the men in charge of a bank and 
the interest or other benefits to be given depositors 
amount to a large sum, the earnings of a bank 
must be made large enough to provide a fair 
return. 

Money Credit Entails Convertibility 
Into Money. 

Banks make their profits by lending (a) money, 
or (b) credit. The first bankers lent money only; 
but as business grew more complicated it was 
found that it was possible to use certain substitutes 
for actual money in business which would pass as 
money, were dependent on money and yet which 
were not really money. These substitutes became 
known as credit. Credit from its derivation 
means belief; and roughly credit has grown to 
mean that substitute for money which carries with 
it the belief that it can be readily converted into 
money if desired. It readily appears that credit 
must necessarily be the great factor in commercial 
enterprise, increasing directly in importance with 
the number of times it is used. If by having 
money where one can readily get at it for any 
purpose and also make it, all or part, earn interest, 
and still at the same time find something which 
based on the money may also be put out at interest, 
a much to be desired result is obtained. This 
something, if it can be found, is credit. It should 



BANKING 156 

be borne in mind, however, thai inasmuch as its 
usefulness is dependent on its ready convertibility 
into money when desired, anything which checks 
the belief in its convertibility tends to hinder its 
usefulness, if nol utterly to destroy it. Credit, 
accordingly, in business necessarily has a larger 
meaning than mere belief. Credit, if genuine, 
must carry with it not only the belief in its con- 
vertibility Into money but also the actual fact of 
Us convertibility , if not immediate, at lens/ within 
a reasonable and known time. In fact, this is the 
reason for referring to this subject of banking and 
credits in this book on commercial paper. 

Credit is the Most Important Factor 
in Our Finance. 

Mr. Henry J). Macleod, in his "The Theory of 
Credit" begins his book with the following quota- 
tion from Demosthenes: "If von were ignorant of 
this, that credit is the greatest capital of all 
towards the acquisition of wealth, you would be 
utterly ignorant." He follow- it by a quotation 
from Daniel Webster: "Credil has done more, a 
thousand times, to enrich nations than all the 
mines of the world." Certainly credil is the basis 
of our present day financial system. As President 
Arthur T. Eadley of Sale, in his "Economics" 
Bays: "The money which an individual uses in his 
business, though 8 accessary pari of his capital, 
often seems like an unproductive one. It' he can 
employ credil instead of cash as a means of making 



156 COMMERCIAL PAPER 

his payments he has a correspondingly larger 
amount to spend in machinery and other perma- 
nent investments whose direct productive power is 
more obvious than that of money." Pres. Hadley 
goes on to point out that credit is used chiefly in 
two cases (a) in very poor communities which 
cannot afford to keep money if it can be avoided, 
(b) in any community of active producers such as 
a new country without sufficient money capital. 
He adds that the use of credit is not necessarily a 
sign of civilization, though highly organized com- 
munities do certain things on credit which less 
advanced communities cannot do. "But when 
such operations have once become established/' he 
says, "the tendency is toward an increasing use of 
cash in their consummation; a practice which 
saves time, saves waste and saves middlemen's 
profits." In other words, if credit tends to get 
far away from its quick convertibility into the 
money on which it is based, the more advanced 
communities see to it that it is brought back as 
quickly as possible into its proper sphere. Credit 
is certainly the greatest factor in our financial 
world. As can be seen, however, even a slight 
misuse of this delicate and all-powerful instru- 
ment will play tremendous havoc with those con- 
cerned. 

Credit Appears in Many Forms. 

There are many examples of credit. The man 
who keeps his money in the bank and draws checks 



BANKING L57 

against it retains the use of his money, which is 
perhaps at interest, and yet gets the equivalent of 
his money through cluck-. [f, as 1ms happened, 
the checks pass from hand to hand by endorsement 
and arc not presented for sonic time, an efficient 
instrument of credit has been in operation. 
Again, the firm which buys a plant and machinery 
with its capital and then on the strength of its 
assets borrows money and buys merchandise to run 
through its plant, makes use of credit. The notes 
of a government, as our own issued during the civil 
war, which are simply promissory and arc not 
based on any definite money or bullion, arc credit 
in another form. Notes such as those of the Hank 
of France which arc based on commercial paper, 
are still another example. 

Different Methods of Different Banks 
Are to be Studied. 

Banks are the chief wielders of credil as well 
a- of actual money. There are many different 
kind- of banks today in operation. In any com- 
munity at all complex specialization must occur. 
Banking has necessarily assumed such a special- 
ize d aspect and now provides, a- well a- each civil- 
ized country ha- been able to work the matter out, 
the best facilities for safeguarding wealth and yel 
furnishing money or credit for legitimate industrial 
enterprise, which can turn the money itself or the 
ere, lit which is based on the money into capitalistic 
form. Each country and community ha- it- own 



158 COMMERCIAL PAPER 

problems and its own atmosphere. What is pos- 
sible in one country is not always so in another. 
There are many similar banking problems in all 
places, however, and a short examination into the 
different efforts ,that have been made to solve these 
problems with the results arrived at is interesting 
and instructive. The different functions banks 
have been, and are, expected to perform are also 
worthy of some notice. 

The First Bank of the United States. 

Our banking system in the United States is the 
outgrowth of the state and governmental banking 
systems of early years. There have been two 
United States banks. The first, organized by 
Alexander Hamilton, was incorporated in the 
belief that it would aid trade and also be able to 
assist financially the United States Government 
in time of need. The bill authorizing the bank 
became a law February 25, 1791. The bill pro- 
vided for a bank of the United States to be located 
in Philadelphia, with a capital of $10,000,000, 
each share to be $400. x One-fourth of all sub- 
scriptions was to be paid in specie, the rest in 
United States stock paying 6%. ISTo subscription 
other than that of the government was to exceed 
1,000 shares. The bank was to be allowed to 
issue notes, which were to be legal tender in pay- 

1 For information regarding the Banks of the United States, cf . 
"The First and Second Banks of the United States." National Monetary 
Commission document No. 571, by John Thorn Holds worth, Ph. D. and 
Davis R. Dewey, Ph. D. 






BANKING 159 

ment ^\' all debts to the United States. The max- 
imum amount of debt the hank might show, except 
for deposits, was never to exceed $10,000,000 
unless the contracting of such debts was authorized 
by Congress; otherwise the directors were to be 
personally liable. The bank was to be under 
private management. Branch banking was per- 
mitted and was practiced. 

The First Bank of the United States 
Was Not a Success. 

The first bank of the CTnited States lent con- 
siderable money to the government, in fact accom- 
modated it as desired, but in many ways it did 
not work well. Its notes circulated fairly freely; 
lmr it refused to accept the notes of its own 
branches, and though in 1792 it aided Philadelphia 
merchants when money was much needed, charges 
of partiality in the lending of it> money and credit 
were very current. Political influence was also 
charged. When the charter of the bank expired a 
new "lie was requested and a great deal of test- 
imony to disprove the charges against the hank was 
put forth. There was much opposition, however, 
and the rechartering of the bank failed. The Firsl 
Hank of the United States closed its doors March 
:;. 1-11. 

The Second Bank of the United State-. 

Within three years after the dissolution of the 
first hank of the United States there came a new 



160 COMMERCIAL PAPER 

demand for a similar institution, chiefly because 
it was felt that some strong hand should settle the 
currency problem, for currency, owing to many 
state banks with the right of issue, was, as we 
shall see, in an utterly disorganized condition. A 
bill providing for a new United States bank 
was accordingly passed. This bank was to have 
$35,000,000 capital, the par value of the shares 
to be $100. One-fifth of the total capital was to 
be subscribed for by the government, and payments 
were to be made one-fourth in specie, the rest in 
specie or in the funded debt of the government. 
Every three years the bank was to make an exact 
statement of unpaid debts and of surplus profits. 
It had the right to issue notes. 

The Second Bank of the United States 
Was But Fairly Successful. 

This bank was chartered April 10, 1816, and 
soon after began business. The first president 
was forced to resign owing to mismanagement, and 
though later the management seems to have been 
better it did not attain the hoped for end of estab- 
lishing a sound currency. As in addition jealousy 
against the bank arose and as also the constitution- 
ality of the bank was much questioned, when a 
short time before its charter expired in 1836 and 
the bill for rechartering the bank came to Pres- 
ident Jackson, he vetoed it. 



BANKING 161 

Both Banks Encountered Unusual 

Difficulties. 

Both the banks of the United States had difficult 
w<>rk to perform, especially the second one. The 
scope of the banks was not clearly defined; much, 
the note issue, for example, was left to the manage- 
ment of the banks to decide on. The managers 
had had no more experience in banking or knowl- 
edge of the theory of it than had the men who 
drew up the hills for the bank. Alexander Hamil- 
ton had been a financier; but many of those who 
succeeded him were not, and when in difficult times 
they tried to build up a satisfactory banking sys- 
tem they failed. A prominent financier has said 
that the banks of the United States held this 
country back thirty years. 

The Currency Was the Chief Problem. 

The most difficult problem the banks of the 

•United States had to deal with, especially the 

•lid bank, was that of the currency. During 

the period of their operation, and more markedly 

after 1 800, the different states kepi giving charters 

for banks to groups of men who seem to have had 

solutely do knowledge regarding the granting of 

credil or the functions of banking. The banking 

of these men was certainly of the crudest sort, for 

they did nol seem a- a whole to know how to learn 

•by their own mistakes or by those of others. 
Prof( — r Davis II. Dewey in the National Mone- 



162 COMMERCIAL PAPER 

tary Commission Document entitled "State Bank- 
ing before the Civil War" has given a graphic de- 
scription of banking in these times. It is well 
worth the reading by those who wish to investigate 
what banking in the rough form means. 

Our Early Banking Was Unsound. 

Of all the functions of banking, the proper 
granting of credit through note issues is perhaps 
the most intricate and delicate. Our earliest 
banks were founded on specie. The Bank of 
North America, 1781, was based on specie obtained 
by the government from France, and the Bank of 
Massachusetts had collected in specie $253,500 out 
of its total capital of $300,000 before it began 
operation. 1 We did not have a sufficient supply 
of precious metals, however, for an extended sys- 
tem of banks such as these. Hamilton recognized 
that we could not found a great national bank on 
specie and so in 1790 recommended the use of • 
government securities as partial payment for stock. 
This was fairly satisfactory, for the government 
was believed to be sound. In the cases of the 
smaller state chartered banks, however, it was per- 
mitted to pay down a small amount in specie for 
stock, to borrow on that stock at the bank and then 
to use the proceeds of the loan to complete the pay- 
ments for the stock. Moreover, in addition to this, 

lFor this and subsequent information, reference is made to " State 
Banking Before the Civil War." National Monetary Commission Doc- 
ument No. 581, by Davis R. Dewey, Ph. D. 



BANKING lo3 

the charters permitted the ban' ssue practi- 

cally unlimited notes based on i 

thing but the comparati small amour/ 

nally paid in :' 31 •'■:. n ~hus is can lily 

lized that a currency situation arose which v a 
about as unsatisfactory as it could be. From l v 12 
few banks seem to have had much 
paid in capital. P — s - that S 

retary Crawford in 182 stdmated that out of 
pital engaged in banking in the 
United - s only about $94, old be 

called paid in. Secretary Crawford estimated 
that only about $75 3 .as active capital. 

Our Early Bank- Could do Almost 

Anytk: 

The business 1 \k under a state 

charter was generally very loosely defined. The 
holding of real estate except for place of business 
was usual' it then 

this rule. In regard * io- 

ns were - tally lax. Many of the acts of 
strict the giving of credit 
through bank tea in any wa; 
limiting amount of ind 

- which usually very _ 

I, the eh 
I no limitation of any sort upon 



164 i COMMERCIAL PAPER 

Our State Bank Note Issues Were 
Fundamentally Unsound. 

It is interesting to note that country banks seem 
to have kept out a considerably greater amount of 
notes proportionately to their capital than did 
city banks. These notes were lent to customers 
and passed according to the repute of the bank in 
its community and the knowledge men in other 
parts of the country had of the bank. As this 
was necessarily small, a very poor credit system 
was built, founded on little real worth, carelessly 
extended and almost unredeemable for currency. 
"The Merchants National Bank of Salem, Massa- 
chusetts," by Mr. Albert W. Dennis, shows how 
even in Massachusetts, which was one of the first 
states to work out a moderately successful system 
for bank bills, notes had various values. This 
history also shows how it was feared that politics 
would constantly influence the granting of bank 
credit. 

Bedemption of Notes Was the Problem. 

In the early charters no provisions were made 
for the redemption of notes. "A Boston broker," 
Prof. Dewey says, "was brought before the grand 
jury of Vermont for demanding payment in specie 
for the bills of one of its banks, on the complaint of 
the attorney-general that he was guilty of an 
indictable offence." In 1819, however, the Suf- 
folk Bank of Boston built up a rough system of 



BANKING 165 

protecting the bills of certain banks. From this 
time on, in spite of mam- attempts to evade 
redemption on the part of banks, better systems 
arose. 

Early Banking Showed Many Abuses. 

A very considerable part of the loans which 
were made during the earlier period of banking 
were accommodation loans. These wore made 
under the prevailing opinion that banks should 
s ve all by an advance of credit irrespective of 
the condition that such credit could promptly be 
liquidated, though in Pennsylvania "the Bank of 
Pennsylvania restricted its loan- to sixty day-, and 
the Philadelphia Bank, l v <>4, to four months." 1 
Later, these banks, owing to the scarcity of short 
time investments, bought four and six months 
paper. Hanks also lent considerably on real estate 
in spite of length of time demanded for the loan 
by the borrower. "In South Carolina the Bank 
of the State, in 1812, forbade renewal- unless a 
year's interest was paid in advance. One-tenth 

the loan was to be called in each Near." 1 ( !lib- 
born, an Englishman, after five years' residence 
in Cincinnati, wrote in L837, 1 a- a result of his 
observation, that banks would not discount unless 
the directors were directly or indirectly interested. 
A more serious abuse was the practice of directors 

endorsing i<>v a consideration of one, two or 
more per cent. 

l"S fore the < ivii War," by Davie i:. Dewey, Ph.D. 






166 COMMERCIAL PAPER 

The Safety-Fund Banking Act Did Not 
Cover Sufficient Ground. 

Different states had different laws regarding 
their banks ; but none seem to have been very suc- 
cessful in their regulation. In New York in 
1829 the safety-fund banking law was passed. 
This law required each bank to which a charter 
was granted to contribute a percentage of its 
capital for a common fund for payment of all the 
debts of an insolvent bank exclusive of its capital. 
Even this scheme did not help matters greatly, 
as was shown in the panic of 1837. Later, too, 
this bank fund proved inadequate to meet the 
demands from all the insolvent banks for both 
notes and deposits, even after an additional assess- 
ment had been made. The theory of the safety- 
fund banking act seems to have been good, but it 
was not deep enough to effect real benefit. The 
result was that the system broke down. 1 

Much of the Later State Banking 
Was Unsound. 

The banking as outlined here continued in 
various phases for many years in this country. 
Most of the banks from 1830 till the Civil War 
grew more successful as the promoters gained in 
banking experience. During the period of state 
banks, however, Mr. Andrew McF. Davis quotes 
in "The Origin of the National Banking System," 

lFor a report on the Safety Fund Banking Act of "The Safety Fund 
Banking Sysiem in New York 1829-1866," National Monetary Commis- 
sion Document, No. 581, by Robert E. Chadwick, th. D. 



BANKING 107 

"it has been satisfactorily ascertained by careful 
examination that the people suffered to the amount 
of more than $100,000,000 by broken bank notes." 
Most of the trouble from the wild-cat banking, as 
it was called, was in the West. Mr. Davis quotes 
one writer, who says that in Illinois over 47 banks 
in I860 wore merely banks of circulation, without 
capital and doing no business at their nominal 
locations. It is easy to see that the credit granted 
by such institutions might cause trouble. It had 
hem proved, as Demosthenes said, that credit was 
the most important instrument in the business 
w<»rld and that any disturbance of it worked 
incalculable injury. 

The National Bank Act Solved 
Many Difficulties. 

When the Civil War came, although banking 
was on a considerably Bounder basis than it had 
been, there was -till many unsatisfactory factors, 
owing chiefly to a poorly secured note issue by 
individual banks. At the same time there arose 
a great need for government financing. Mr. 
Salmon P. Chase, the Secretary of the Treasury, 
solved these two problems together. He planned 
an act which became a law providing that banks 
to have right of note issue should incorporate 
under a aational charter ami that they should 

jure their notes under strict limitations with 
- ernment bonds only. This scheme at once 
placed an artificial value on government bond-. 



168 COMMERCIAL PAPER 

which was greatly to the government's advantage. 
It also ensured safe and uniform note issues on 
the part of the banks in the country. The act 
incidentally solved other problems. It provided, 
for example, for rational reserves against deposits, 
and gave the name to banks incorporating under 
the act of "national banks/ 7 as a signal to all that 
banks bearing this name were conservative in their 
operations by necessity. ~No attempt was made 
to change greatly the older system. There was to 
be no central bank. The system of separate units 
still remained, only their operations were re- 
stricted and they were put under government super- 
vision. At the same time the plan of operation 
under the national bank act was made so attractive 
as to force the old state banks to exchange their 
old charters for new ones under the act. 

The National Bank Act Has 
Permitted Prosperity. 

Mr. Chase aimed at the business banks of the 
community, the banks Avhich concerned themselves 
chiefly with the mercantile demands of the country, 
those which naturally were required to give and 
protect credit. Incidentally, he arranged for a 
very small expansion and retraction of the cur- 
rency. How well the plan has worked, time has 
shown. Comparatively speaking, we have by this 
act secured safe banking and certainly better bank- 
ing than we had before. Credit, both the giving 



BANKING 169 

of it and the protecting of it, has been betteT 
understood and insured than it was before, hnt 
whether our banking system has yet attained even 
a near approach to adaptability for its environ- 
ment is an open question. We may at any rate 
- y that we have prospered under the national 
hank system of this country, and that, if it has in 
places nol suited the country, the country has at 
least partially changed itself to suit it. The 
wheels of the system have kept constantly turning. 

Savings Banks are Primarily for the 
Benefit of the People. 

The national banks have eared for the mercan- 
tile demands of the country. Deposits with them 
have led to business loans. They have necessarily 
kept in touch with the general business condition-. 
There are in any extensive community, however, 
a large number of people who do not need hank 
accommodation, and who wish only to save money, 
and to make it earn something and he al the same 
time safe. To provide banks tor these and to 

5ter Buch saving a- being for the general welfare 
the community, the several states have per- 
mitted the organization of so called savings banks 
whose province is primarily • tard die earn- 

ings in -mall amounts of the citizen- of the states, 
without ;it the Bame time having any especial 
demand on them t.. aid the mercantile needs of 
the community. These hank- have also been 



170 COMMERCIAL PAPER 

formed to lend on real estate as being especially 
suitable an investment for this money. Each 
state has formed its own laws for such banks, prac- 
tically all of these laws differing from each other 
in some respects, but all aiming at conservatism of 
investments consistent with the gaining of a fair 
rate of return for the depositors. The best of 
these banks are without capital, it being felt that 
as they are organized for the people only, and have 
had thrown around them especial safeguards as 
to their deposits, anything which they may earn 
shall go to the depositors either as interest or for 
strengthening their security. Most savings banks 
in New England, New York and certain other 
eastern states are of this nature. Savings banks 
ought to be and are benevolent or semi-benevolent 
institutions. 

Co-operative Banks are Similar 
Institutions. 

Go-operative banks, such as are now so success- 
fully in operation in Massachusetts, are but a 
variation of the same idea. Their field is that 
especially of the men of small means who wish 
to build houses. They cater particularly to such 
men and are serving them exceedingly well by 
safeguarding their money, paying interest on it 
and at the same time affording their depositors 
the opportunity to build houses under proper 
financial guidance. 



BANKING 171 

Trust Companies and State Banks are 
to be Classed with National Banks. 

We have also in this country trust companies 
which haw become variations of national hanks, 
though organized at first under state charters to 

rare for trust property, to act as fiduciary agents, 
administrators, etc., with the idea that it is better 
to appoint a corporation as agenl in the care of 

money rather than individuals, when that care 
must extend over a period of years. These banks, 
having gained liberal opportunity to enter the 
aeral banking business, are gradually filling not 
only the field for which they were originally 
designed, but are encroaching on the business of 
mercantile national hank-. Having usually to 
keep a smaller reserve than national banks must 
against deposits, it' they -ee fit to compete generally 
with these national banks they must become a still 
_ later factor than they are new in the banking 
machinery of the country. State bank-, which 
are banks intended to fill much the -nine field as 
national bank-, but operating under state charter-, 
are to be classed broadly with national bank-. 
S tte bank-- may often lend on real estate a- well 
a- in mercanl tie transactions. 

The Strength of Private Banking Houses 

is Dependent on Their Free Capital 
and Their Ability. 

There are in the United States, a- elsewhere, 
many private banking houses. Abroad these take 



172 COMMERCIAL PAPER 

more the form of banks, and this they are doing 
here to a considerably larger extent than they did 
a few years ago. Some in this country have large 
resources, but most have not. They are all much 
alike, being in existence chiefly to make a profit 
from turning over securities from one man or firm 
or corporation to others. The strength of each is 
dependent on the amount of free capital each 
keeps in reserve, the sort of securities purchased 
and the ability of the firm to dispose of these 
securities once they are acquired. In dealing 
with such houses these factors in their strength 
should be considered. 

The Bank of England. 

Opposed to our banks are banks like the Bank of 
England. The Bank of England is a bank of a dif- 
ferent type from anything we have yet seen in this 
country. It is a governmental central institution 
planned to control the reserves of the nation and 
also to control circulation. The bank consists of 
two parts, the banking department and the issue 
department, both being absolutely distinct and 
separate. Both parts are managed by civilians, 
that is, by non-governmental employees ; but the 
government is at all times actively interested in 
the bank, using it as its chief fiscal agent and 
giving it its moral and even stronger support when 
necessary. With the exception of a very few insti- 
tutions which have retained the right to issue bank 
notes to a small extent, the Bank of England has 



BANKING 173 

a monopoly of note issue in England. No notes 
other than those of the Bank of England arc legal 
tender. 

The Bank of England Issues Notes 
Almost Wholly Against Gold. 

The Bank of England issues notes, first against 
Government debt, the proportion of this class of 

notes, which is limited to the now outstanding 
notes, being about one-fifth. Second, the Bank 
issues notes against certain other securities, this 
class of notes being also limited in amount and 
representing largely the right of banks other than 
the Bank of England to issue notes which the 
Bank of England has acquired. The proportion 
of this class of notes to the total outstanding notes 
i- about one-eighth. The third and lasl class of 
notes is issuable against an equivalent value of 
bullion, chiefly gold. No silver hag been used as 
a basis of note issue for many year-. 

England Has an Inelastic Currency. 

The currency system of Phi-laud is absolutely 
inelastic. The fiduciary circulation, against gov- 
ernment debt, etc. i^ comparatively insignificant, 
the increase and decrease in the amount of circula- 
tion being parallel absolutely with the amounl of 
bullion deposited against not.- issue. Twice in 
times of crisis the act regulating the note issue 
has h'-rn suspended, allowing notes to 1»" put out 
beyond the authorized fiduciary issue which were 



174 COMMERCIAL PAPER, 

unsecured by bullion; but it is the belief of Eng- 
lish students of finance that a crisis would no 
longer necessitate such a procedure, owing to the 
increased use of checks. These, they say, would 
now replace any lack of currency. The chief 
factors in the English system, as readily appears, 
are therefore (a) a monetary system based prac- 
tically wholly on gold and inelastic excepting with 
an increase or decrease in the gold supply held by 
the Bank of England, (b) a great central reserve 
held by the Bank of England, a reserve of all the 
great banking institutions of the country and a 
reserve in shape for immediate use as needed, (c) 
a central agent for use in finance by the govern- 
ment. 

The Bank of England is a World Power. 

The banking department of the Bank of Eng- 
land is the great depository of the other English 
banks including the London clearing house banks. 
It pays no interest on any deposits and discounts 
for customers only, but this it is always ready to 
do even in times of stress. As a bankers bank, 
it keeps a very large reserve itself constantly on 
hand, this reserve ranging often to 50%. In 
behalf of the system of which it stands at the head 
and on behalf of the financial stability of the 
world, the Bank of England, not because of any 
law, but from a so-called implied duty, regulates 
the supply of gold in the country. This it does 
by raising or lowering its rate of discount as it 



BANKING 175 

thinks advisable and by borrowing as much money 
as ir think- advisable in the open market through 
advanced bids for thai money. From the prestige 
given the Bank of England by its constant strength 
and successful history, from its efficient aid in 
times of need and from the government money it 
cares for, the Bank maintains itself as the chief 
factor in the English world o\' finance. From its 
size it is able to regulate the amount of credit and 
through this the gold supply that shall be granted 
t<» the English people and — in a way — to the 
w<»rhl. In other words, it has made itself a 
national and almost a world discount market. 

English Banking Has Been Consolidated. 

There are other English hanks, London and 
country, tin 1 large London banks having branches 

ttered throughout the country and competing 
with the so-called country banks. There has been 
a strong tendency towards consolidation in English 
banking, however, with the result thai mosl of the 
banking i- now done by comparatively few hank-. 
S me of them, as we have said, bave the right to 
issue notes to a Limited amount, hut none to issue 
notes which shall be legal tender except the Bank 
"t" England. 

The Bank of Prance. 

'Idie Bank of France, like the Dank of England, 
i- a private establishment with a paid in capital, 
but in this case the government, in the selection 



176 COMMERCIAL PAPER 

of the officers of the bank, has even more active 
interest than the English government has in the 
Bank of England. Branch banking is allowed 
and is practiced very extensively, far more so 
than in England. As stated by one of its officers, 
the purpose of the Bank of France is to do all the 
banking business possible that is consistent with 
a bank of issue. Like the Bank of England it is 
especially a banker's bank and stands ready to 
discount for or to assist any other bank which 
may need aid. Its business differs considerably 
from the Bank of England, however, in the 
number of small clients it has brought in by its 
branch banking system. ~No over-drafts are al- 
lowed. 

The French View of Banking Differs 
From Much of Our Own. 

The French in their banking, as in their law 
and literature, take a different point of view of 
matters than do the Anglo-Saxon nations, no less 
logical but unlike them in kind. This is ex- 
pressed most clearly in the answers to certain 
questions put to M. Pallain, Governor of the Bank 
of France by the United States Monetary Com- 
mission. Asked in regard to the cash reserves 
kept by other banks with the Bank of France, he 
answered "In France we consider the strength of 
a bank consists more in the composition of its 
portfolio, i. e., in the value of its commercial bills, 
rather than in the importance of its cash reserve. 



BANKING 177 

Q. In America the question of the proper rela- 
tion beween cash in hand and liabilities is con- 
sidered very important J 

A. Ir appears to us that for French private 
banks the proportion of cash to liabilities is l< ss 

jnificant on account of the facilities offered by 
the organization of the Bank of France for the 
rapid conversion — in a crisis — of a good portfolio 
into ready money. The part which the Bank of 
France plays toward the private establishments 
permits the latter, as has many a time been 
proved, to reduce to a minimum their cash reserves 
and to devote, without exceptional risk, a larger 
part perhaps than elsewhere to productive com- 
mercial operations. 

Q. That may be true, but we wanted to find 
out, if possible, the percentage of the cash held 
by the hank- of Paris in their vaults to their 
>sit liability 

A. T think you pay more attention to the 
quantity than to the quality. 

( v >. P<> the banks rely implicitly <>n the Bank 
France to grant them credit when they require 
ir 2 

A. They know very well thai in time of diffi- 
culty we are the supreme resourc 

( J. I >oes the amount and the character of 
lit granted to the other banks depend on the 
amount and the character of their accounts at 
the Bank of Franc 

A. fhere is no fixed rule. It i- more espe- 



178 COMMERCIAL PAPER 

cially the quality of the paper presented which 
fixes the extent of the credit. 

Q. Is the Bank of France regarded as a bank 
for banks or as a bank for the people ? 

A. The Bank of all the French public. 

French Note Currency is Based Chiefly 
on Commercial Paper. 

Answers like these and along other lines in this 
most interesting inquiry, developed that the Bank 
of France has a monopoly of note issue in France ; 
that this note issue is based largely on commercial 
paper, and that the note issue is taxed to a small 
degree only by the government according to a cer- 
tain scale of outstanding notes, limited as to a 
large maximum, a maximum which may be 
changed if the need arises. Asked if there was 
any feeling that banks other than the Bank of 
France should have the right to issue note, M. 
Pallain said: 

"The unity of issue was achieved in France in 
1848 and at no time since then has there been any 
question in responsible circles, of a possible return 
to plurality of issue. The same tendency is lead- 
ing little by little to an absolute monopoly in 
England, Germany, and even in Italy. I think 
it would be interesting for you to examine the 
recent example of Switzerland, which had its note 
issue founded, as in America, on the plurality of 
banks and which has now substituted for this sys- 
tem one single privileged bank. This trans- 



BANKING 170 

formation has received popular approval by ref- 
erendum." 

Q. We have in America a numerous class of 
people who think that the discount banks could 
better serve the interests of their customers if 
they had an additional right of note issue, based 
on commercial assets. What is your opinion i 

A. My opinion is very clearly favorable to the 
principle of unity of issue. In normal times the 
available funds arising from note issue should only 
be employed with moderation so as to retain their 
efficacy in periods of crisis, and it appears to me 
that this moderation would be less well assured 
by the competition of a large number of establish- 
ment- than by the control of a sole responsible 
hank, which would become the supreme refuge of 
all the others in times of peril. 

The Xote Issue is Dependent Absolutely 
on the Proper Commercial Demand. 

The inquiry shows clearly that the Bank of 
France governs it- note issue entirely by the com- 
mercial demand- <>n it. If a demand comes for 
discount of such hill- as it considers eligible for 
it- portfolio, the notes or currency are forth- 
coming. [1 would make do diffeerence, M. Pal- 
lain -aid, whether the note- fur discounl were 
presented by banks or by customers in general. 
Even the exportation of gold would qoI aeo 
sarily decrease the volume of outstanding nol 



180 COMMERCIAL PAPER 

Q. There is nothing in the law requiring your 
notes to be covered by a certain proportion of 
gold ? 

A. No regulation of this kind exists in our 
legislation. 

Q. There is no provision that you should hold 
either cash or bills of a certain character against 
the note issue ? 

A. As regards cash we have no particular 
obligation. The bills must simply have the ma- 
turity and the signatures stipulated in the statutes. 
But the more latitude that is allowed us, the more 
we feel ourselves bound to insure by the character 
of our management and by the constitution of very 
strong reserves, the complete security of the bank 
note. 

Q. Is there anything in the law requiring your 
notes to be covered either by cash or bills ? 

A. The Bank of France can issue notes as 
against cash or against statutory discounts or 
loans. Every note has, therefore, its counterpart 
either in the metallic reserve, or in the portfolio of 
discounts or in loans. As these latter operations 
are subjected to special conditions of security, one 
can say that the French legislator — as I have 
already pointed out to you — gave more thought to 
the quality than to the quantity of securities 
offered to note-holders. 

Q. What classes of bills are discounted by the 
Bank of France ? 

A. The Bank of France discounts for every- 



BANKING L81 

one who has obtained the opening of a current 

account, hills of exchange, checks, bills to order 
and commercial and agricultural warrants of a 
fixed maturity which have not more. than three 
months to run and which hear the signatures of 
three person-, tradesmen, agricultural syndicates 
or others, known to he solvent. The Bank and 
the branches accept without distinction hills which 
are payable in any of the 167 towns where we 
undertake to collect bills. 

Q. Do you require three names on all the 
bills you discount I 

A. The statutory rule is that hills must have 

three signatures, hut the Bank is also authorized 

pt paper bearing only two signatures when 

the third signature is replaced by a deposit of 

mrities belonging; to one of the classes of secur- 

es admitted for loans or by a warrant for mer- 
chandise (warehouse receipt). When 1 -peak of 
hill> bearing two signatures I mean French signa- 
tures, and I mean to say that bills with three sig- 
natures must have, among these three signatui 
at least two signatures given by parties domiciled 
in France. 

The French Credit System Has 
Worked Successfully, 

M. Pallain showed clearly that with the Bank of 
Qce exists a credit system beautiful in it- pure 
simplicity ;i- to theory and perfeel in it- working 
It a man has capital in France and transfers it 



182 COMMERCIAL PAPER 

into fixed form such as machinery, he can still 
make use of it as money capital by giving his note 
under very carefully stipulated provisions to the 
Bank of France for discount. If the Bank of 
France does not happen to have a sufficient amount 
of currency and its note issue is below the large 
fixed maximum point, it prints more and gives 
them to the customer wishing discount in exchange 
for his note. At first this would seem a dangerous 
practice, but so good is the paper that the Bank 
of France accepts in this way, so many safe- 
guards are thrown around it, so educated have the 
French people become to the necessity of safety 
in credit and so careful are the managers of the 
Bank always to have a large gold reserve, that the 
system never goes astray. 

France Has a Larger Power Over Gold 
Than Has the United States. 

The French note issue is said to be always amply 
protected, constant credit for all deserving ones is 
assured, a national discount market is always at 
hand and many of the rough edges accompanying 
the getting and the giving of credit in this country 
are done away with. With any study of this 
French banking system, however, two important 
factors in its commercial environment must be 
borne in mind, (a) that France is a very old 
country with great individual wealth and much 
capital, (b) that, as M. Pallain points out, France 
is always a creditor nation in its position toward 



BANKING LS3 

the principal foreign markets. Gold will always 
flow towards France, and there is not the need 
of an artificial gold reserve such as we, for 
example, could hardly do without. 

The Reichsbank. 

The Reichsbank, or the central bank of Ger- 
many, is also privately owned, but is managed 
under direct governmental supervision. It has 
many hundreds of branches and makes itself felt 
in all parts of the Empire. Like the Bank of 
France tin- great bank is a bank not only for 
bank.- bur for the people. With it, too, the direct 
policy is to give discount to all who ask it provided 
the notes for discount are legal for it to buy. The 
fact that a man wishing to discount a note has 
no account with the Reichsbank would not prevent 
his getting it discounted. The Reichsbank dor- 
not pay interest on the money deposited with it; 
but make- it of advantage to most Large houses to 
keep an account with it, doing a Large transfer 
business tor them. Large bank- also keep much of 
their reserve with the Reichsbank. The bank 
purchases government securities, Largely in the 
form of very short time note-. It also acts as 
the fiscal agent of the government an. I a- such 
performs very good service owing to its many 
branches, h is primarily, a- the management of 
the hank ha- stated, a public institution which is 
to care for the public interest, and secondarily a 
money making institution. 



184 COMMERCIAL PAPER 

The Eeichsbank Has a Monopoly of Issue. 

The Reichsbank now has a monopoly of the 
right of bank note issue in Germany. One of 
its first duties it considers is to regulate the 
amount of currency in the country, but unlike the 
note issue of the Bank of Trance its maximum 
issue is regulated by the amount of precious metals 
it holds. It may cover these metals with its 
notes, then the amount of Government notes it 
holds, then it may issue a certain and definite 
amount of uncovered notes, then it may cover with 
its own notes the notes of other banks held by the 
Reichsbank. After this sum, it may issue more 
notes on which there is a considerable tax, but its 
maximum note issue shall never be greater than 
three times the amount of precious metals and gov- 
ernment notes it holds. The amount of silver it can 
hold is dependent on a protective regulation. 
Moreover, all notes issued in excess of precious 
metals and government notes held must be covered 
by bills discounted, the form of these bills being 
regulated by law. 

England, France and Germany Have 
Other Than Central Banks. 

In England, France and Germany there are, of 
course, beside the central institution, many banks, 
some of them formed for special purposes such as 
to encourage agriculture, to aid general business, 
or to finance large undertakings. These are all 



BANKING 186 

built, however, especially in France an J Germany, 
about the central bank and have grown largely 
dependent on it. In most cases the other luniks 
regard profil to themselves as of chief importance, 
though this profit is dependent on all usefulness 
that is consistent with it. 

Each of These Countries Has a 
Central Beserve. 

From such examples as the great bank- and 
banking systems of Europe we can learn many 
lessons. As has been shown, each country lias its 
own individual conditions, and the same problems 
in different countries may not necessarily be solv- 
able in the same way. Much that older nations 
discovered, however, we should pay great 
attention to, and it seems as if we should profit 
by the application of at least some of their methods 
to our younger and cruder finance. There is one 
Btaring factor in the financial Bystem of Europe 
which we have not here that must at once catch 
eye of the investigator. It is the fact thai 
every one of the countries we have examined has 
a central reserve compounded of all the reserves 
of the different financial units of the country and 
all ready for immediate use when needed most 

Banks Musi Save a Large Gold 
Beserve Available. 

•in a revi 'Ik- banking we have examined 

in the foregoing pages, it seems clear that any 



186 COMMERCIAL PAPER 

body of men engaged in any extensive banking 
operations should have a definite capital unchange- 
able as to the minimum of such capital. The 
more surplus or additional capital that can be 
made available in addition to the original min- 
imum capital, the better for the strength of the 
organization. Equally important, however, with 
a consideration of the capital and surplus of an 
institution is the reserve of a bank. In banking 
it is as easy to do too much perfectly good business 
on the capital employed as in the average of mer- 
cantile affairs. Bank reserves are to be con- 
sidered in the next chapter. Suffice to say that 
a history of the world's banking shows clearly 
that in all good banking (first) there must be a 
very strong gold reserve, stronger for reserve 
agents than for others, (second) there must be 
secondary reserves which can be quickly converted 
into gold if necessary. 

Banks are Public Servants, but They 
Must Make a Profit. 

If capital is employed, and if it is to be true 
capital, it must increase, and for this reason a 
bank with capital can afford to keep as reserve 
only enough to insure safety to its depositors. 
Banks in this country are institutions formed to 
show a profit and as such, if they serve their 
depositors by insuring the safety of deposits by 
the amount of their capital, they should be entitled 






BANKING 187 

to a fair return on that capital. A> a matter of 
tact, luniks stand in a peculiar position to the com- 
munity for they arc s<> sensitively tied to the busi- 
ness life around them that oftentimes when they 
have great opportunities for profit they arc morally 
bound nor to take advantage of them. On the 
other side, it is to ho said that over a period of 
ars it is host for the profits of hanks in general 
that they should not take advanti - such oppor- 

tunities. Abroad, in the elder banking commun- 
ities, this moral obligation is felt far more keenly 
than it i> here. There, with the large banks and 
the single control of the discount markets, public 
and government influence is enough to keep the 
hank- from using their great power arbitrarily if 
the temptation shows itself, which from the spirit 
banking abroad cannot he often. In this 
country no such great influence is at work, or if 
it is at work there is no general way of making 
it felt. 

We Have Xo National Discount Market. 

Wo have no national discount market, and have 
trust largely to the particular banker with 
whom we deal a- to what a fair rate of discount 
i- and to the active competition between hank-. 
A- a matt fact, however, though rates for 

four month loans may vary a halt' of one per cenl 
between New Xork ami Chicago, it i- owing to 
unequalized local conditions. The spirit of fail-- 



188 COMMERCIAL PAPER 

ness in our banking, coupled with competition of 
banks, has been enough to prevent exorbitant rates 
over any period. A national discount market 
might affect the disparity between rates in dif- 
ferent parts of the country at any one time, but it 
probably would not affect greatly the average rate 
of discount. 

Bank Stock is Not a Desirable Invest- 
ment for Women. 

We have seen that banks are to some extent 
forbidden to take advantage of certain great 
opportunities for profit which occasionally arise, 
whereas in other businesses no such restrictions 
are evident. Unless it is felt by an investor, 
therefore, that stock of a bank under its manage- 
ment is a particularly safe investment, that stock 
is comparatively speaking not so profitable an 
investment as is the stock of a company engaged 
in some other business. Other things being equal, 
the rate of return on bank stock is apt to be less 
than on the stock of equally successful corpora- 
tions in other lines. Moreover, on most bank 
stock there .is a liability in case of failure. Unless 
an invesfor, accordingly, is to derive other benefits 
from holding bank stock, such as intimacy through 
the board of directors with other banks or with 
business conditions, that stock is not a desirable 
investment. For women it cannot be regarded 
as suitable except under exceptional conditions. 



BANKING 180 

Banks Perform Many Services. 

All banks are used as depositories of money 
wealth for many reasons. The keeping of a con- 
stant account with a bank in this "country carries 
with it usually the right to claim a fair share of 
the money the ka.nk is willing to lend for certain 
portions of the year. If a man is a Large bor- 
rower, it is essentia] for him to win the good will 
<-f a hank through keeping a deposit with it, the 
size <»f his deposit varying with his needs. Then, 
too, the keeping of a deposit with a hank opens 
to the depositor the experience, judgment and 
advice of the bank's officers. It also gives to the 
depositor many of the facilities for gaining in- 
formation that are available to the men in charge 
of the bank. It i< a- safe holders of accumulated 
wealth, however, that hanks first arose, and it is 
in this province that they perform their most 
important function-. 

Banks Can Invest More Successfully 
Than Can Individuals. 

Banks can protect wealth hotter than indi- 
viduals can and yet give all the advantages to the 
owner- that they had originally. Having once 
money in large amounts with the tacil permis 
sion of the depositors to turn this into capital, 
banks can, because of their size, wield ii to show 
an increase in geometric proportion better than 
individuals can. There is a poinl <>t' diminishing 



190 COMMERCIAL PAPER 

returns in the banking world as in those of other 
businesses, but it is far removed from small sums, 
and it is seldom that a bank is not considerably 
better able to invest all its money to show an 
average greater return than is the small investor. 
This is partly because it has money to lend in 
bulk; chiefly, however, because its officers are 
students of fundamental business conditions and 
can pick and choose its investments to greater 
advantage than can an individual. A bank acts 
as a clearing house of information. The fact 
being known that it is likely to have money to 
lend makes all possible borrowers appeal to it for 
loans. It thus gets a broader view of the loan 
market than its customer can. Also, many dif- 
ferent men in different trades being interested in 
a bank through having deposits with it, the bank 
profits through its opportunity to obtain special- 
ized advice. 

Banks Should Diversify Their Investments. 

Occasionally one sees a bank or a group of banks 
living the narrow life of making their loans all 
among one class of customers, such as shoe and 
leather merchants or mill treasurers. This may be 
necessary owing to the depositors being all of this 
class or it may be deemed advisable because the men 
who have charge of the bank know well the trade 
to which the loans are made and do not know well 
other business borrowers. If the particular trade 
has a period of difficulty, however, the bank 



BANK INC 191 

usually feels the strain greatly, so thai it' possible 
ir is best for a bank to distribute its loans over 
a somewhat varied field. Ir is the doing so that 
builds up the strongest banks and ii is largely the 
chance to do so that makes the bank a more desir- 
able investor of funds than their owners are. 
Diversified investment coupled with a list of loans 
in which no borrower greatly predominates prac- 
tically insures a bank against many losses coming 
at once. Moreover, if the officers of the bank 
study fundamental business conditions, and con- 
tract and expand the loans in accordance there- 
with, losses arc practically eliminated. If a mis- 
take is made and a loss does occur it is not 
seriously felt, especially if the bank has a propor- 
tionately fair amount of capita] and surplus. 

Banks Should Compete in Other 
Tl lings Than Interest. 

ddio difference, if any, between the interest thai 
a hank pay- on it- deposits and the interest the 
owners could gel at first hand, is the insurance 
the original holders of the deposits are willing to 
pay to protect themselves from any possible loss 
in making their own investments, or the interest 
they are willing to pay for the good will or con- 
venience of the bank. In saving banks such as 
we have in the United States today, the interest 

ich the bank pays is, if anything, -router than 
that which the owner of the deposit drawing in- 
terest could with - xpect to get for himself; 



192 COMMERCIAL PAPER 

but in the case of national banks, trust companies, 
etc., it is often less, and for these the preceding 
law is governor of the amount of the deposits. It 
is for the advantage of such banks, therefore, to 
aid its depositors in every possible way it can 
and to make depositing with it attractive. It is 
in this attraction that the competition should and 
must come. Mercantile banks can afford to pay 
something on many of their deposits ; but com- 
petition between them should not take the form 
of a war of interest. 

Exceptionally High Rates on Deposits 
Are Not Usually Desirable. 

A mercantile bank which pays on deposits an 
unusually high rate of interest, unless it has an 
exceptional surplus, is forced from this very fact 
when it enters into competition with other banks 
for buying the loans from which it makes its 
profit, to choose those loans which bear the highest 
rate of interest, many of which may be passed by 
its competitors owing to lack of security. Its 
investment list is apt to be a comparatively weak 
one. The bank, therefore, that when paying in- 
terest on a deposit, which can fairly claim the 
right to interest, pays what in its community is 
regarded on the average as a fair rate is usually a 
much stronger institution, other things being 
equal, than the bank paying a higher rate. Three 
per cent may be taken as a maximum that com- 






BANKING 198 

mercial banks should pay on deposil accounts. 
No interest should be paid on borrowing accounts. 

Banks Must be Safe Depositories 

for Money. 

The first province of a hank is to safeguard the 
available wealth entrusted to it. From the begin- 
ning of banking this is apparent. For this pur- 
pose primarily hanks were instituted and all other 
duties and opportunities of a hank are secondary 
to it. The protection of the credit system by a 
central hank, the aid which it must extend 
to its government in times of need, are most im- 
portant; but they are as nothing if in fulfilling 
those duties the hank fails to safeguard its 
dej Everything beyond the line of ahso- 
lute safety of its deposits must he avoided in any 
proper banking m. The hank is chiefly a 

public servant. l\ exists to take charge of the 
available wealth of its community, to foster it, 
it if possible, and by so doing to aid 
omunity in the best way economically thai 
it can. If in this work it can show a profit for 
If. well and g 1. hut it- foremosl duties are 

• aild explieit. 

Most Banks Appreciate Their 
Foremost Duty. 

i shocking to a civilized com- 
munity, eager to advance, and storing an available 



194 COMMERCIAL PAPER 

wealth to accomplish this purpose, as a bank 
failure. Fortunately in this country there are 
few banks today that do not take the attitude of 
trustees of available wealth, not only for the sake 
of their depositors but for the sake of the com- 
munity in general. 



CHAPTER VI 

THE REDISCOTTNTING OF COMMERCIAL PAPER 



"T IK T1IEX individuals and corporations have 
V/ V surplus money to invest for a short 

time, and when suitable means of in\ 
nation and reasonably sure information regard- 
2 business conditions are at hand, there is noth- 
ing so fitting for such ii. 3 - a- the best com- 
mercial paper of the" desired maturity. We hi 
a a that commercial paper, if properly issued, 
i- secured by the most salable sort of collateral 
with a margin of safety bark of it. As it has but 
short time to run. it • - cially well 

the g a of interest. There is small danger 

that the paper cannot be converted into cash at 
maturity, and there should be no danger of a 
— or that a large commission will have to be 
paid in procuring that cash, as is possible in the 
se of even a standard long time bond or similar 
security when bought to hold for a short time. 

Individuals or Corporations Investing 

in Commercial Paper do Xot 

Usually Xeed to Resell. 

Moel individuals or corporations having funds 
applicable for the discounting commercial 

pa] i very nicely just how -<»<>n they 

will need the money which they are to pur at in- 
terest Moreover, such individual- do n<>t 1,. 



196 COMMERCIAL PAPER 

very large sums to invest in this way. They can 
almost always, therefore, pick the maturity they 
need, buy the paper they choose, and simply put it 
away till it matures with no thought of needing to 
raise even a part of the money they have let at a 
time prior to the time they have specified in their 
own minds. If they do need to rediscount any 
of their paper investments, the amount they wish 
to market is usually so small that their own banks 
or friends can and will absorb readily all that they 
desire to sell. For such investors as these, so far 
as their needs are concerned in this especial in- 
stance, there is no great necessity of any oppor- 
tunity for rediscounting commercial paper. 

Banks Often do Need to Eesell 
Commercial Paper. 

The case of banks is very different. Banks, 
like private investors and like corporations in their 
slack periods, figure nicely as to when they will 
need their money and very largely invest such 
money as they may need within a comparatively 
short time, in commercial paper. Oftentimes 
when the maturity of the notes taken arrives, these 
institutions do not need the money they receive 
and again discount paper. Banks being 'fiduciary 
agents should always prepare for a larger amount 
of maturities than a smaller one over or under 
what they think they may need at the time they 
are likely to be drawn or called on to discount 
their own customers' notes. Very often, however, 






REDISCOUNTING OF COMMERCIAL PAPER 197 

though finding the investments they wish, as they 
deal in large amounts, banks cannot gel jusl the 
maturity they most desire, and, unless they feel 
Btrong enough to take a less valuable maturity, 
they are forced either to lose through tiol putting 
their money at Interest or to discount paper of 
which they have less knowledge or which they 
admit is nol as strong as that first -elected. 

England Bas a Large Surplus Always 
Ready for the Rediscounting of Paper. 

In England, the London banks are able to carry 
very large reserves and buy only very short time 
receivables or like paper with the money they 
think they may shortly need; but in the United 
States there is bul a small amount of very short 
time paper available for discount, and with our 
-mailer capital for the work to be done reserves do 
not ><> readily accumulate. A- banks are acting 
i'or a very large number of active businesses, even 
the active bank officers unless they are very care- 
ful students of fundamental conditions, are apt 
to make a mi-take in judgment as to when a call 
for money is coming either in the shape of a with- 
drawal of deposits or for the discounting of cus 
tomers' paper or both. It is essential, therefore, 
oftentimes, for hank- to rediscount commercial 
paper. I? ig equally essential under our present 

stem, in «»rder to alh.w hank- to purchase the 
best paper thai they feel is offered them and to 



198 COMMERCIAL PAPER 

permit them to prepare for any emergency, that 
some general method of rediscounting commercial 
paper be in vogue. 

We Have no Large Sums Available 
for This Purpose. 

Mercantile banks array their investments some- 
what in the form of the reserves of an army. 
Their first reserve is cash. Their secondary re- 
serves at present are call loans and short time 
active collateral loans. Their third reserves are as 
a rule commercial paper, which is often well in the 
rear and more than occasionally very slow in reach- 
ing the front in time of trouble. There is at 
present no quick way of hurrying any large 
amount of this third reserve into action. 

France and Germany Have Prepared 

Especially for the Rediscounting 

of Commercial Paper. 

The large English banks other than the Bank 
of England take pride in not calling on the Bank 
of England when they are at all pressed to redis- 
count their bills ; but the Bank of England is 
there with the chief reserves of the nation ready 
to make use of them in any legitimate manner that 
will best remedy a disturbed situation. The mere 
moral support of such a quick reserve as England 
has undoubtedly does much to support English 
banking. The knowledge is general that if any 



REDISCOUNTING OF CX)MMER( [AL PAPEB 199 

bank depositing with the Bank of England wishes 
to rediscount its bills it can do so. In France and 
Germany the situation as regards the rediscount- 
ing of commercial paper is even better. The Dank 
of France in France and the Eteichsbank in Ger 
many hold the reserves of their country chiefly to 
discount notes, that is, commercial paper, broughl 
to them for discount. As any large drain on these 
reserves would have to come from the hanks, it is 
for these chiefly that the reserves are held, and to 
assist these in maintaining a sound banking sys- 
tem. In both France and Germany, however, 
legislation and custom have gone farther than to 
supply a great central reserve fund, an accumula- 
tion of the reserves of the separate units in the 
a stems headed by the Bank of France and by the 
Eieichsbank. In both of these countries, provision 
has been made, far above the usual needs of the 
country, for a currency 9ystem which shall be 
legal tender and which shall be applicable chiefly 
for the discounting and the rediscounting of com- 
mercial paper in times of exceptional demand. 
The German scheme is more conservative than the 
French; but this is possibly because the need of 
conservatism is greater in Germany. Both plana 
produce the same result as does the English central 
rve on a -mailer scale. They arrange for 
short time financial aid to any individual, firm, 
bank, province or, in fact, to the whole country, 
and without any marked disturbance of money 
rat 



200 COMMERCIAL PAPER 

With Foreign Banks Commercial Paper 
Forms Largely the First Eeserve. 

The result is that in France and Germany and 
in England also, though to a less degree, com- 
mercial paper forms the first reserve of the banks. 
Each bank knows that if it needs money, provided 
its paper is in the carefully guarded form pre- 
scribed by law or custom, it can at once obtain prac- 
tically any amount of money it wants by redis- 
counting its paper at the central institution. It 
also knows in France and Germany that if there is 
need, the supply of money will be raised to suit the 
demand, so that no very serious effect on interest 
rates in the country will follow a demand for large 
discounts. Business can be done on a comparative- 
ly small cash reserve in the vaults of the bank pro- 
vided a reasonable reserve is kept with the central 
bank, even though this deposit is not very large. 
Central reserves, therefore, apart from any right 
of note issue that may go with them, do two things. 
— (a) They permit safe banking in ordinary times 
on a smaller aggregate reserve than in the case of 
a series of units none of which are connected — 
(b) They permit the rediscounting of large 
amounts of commercial bills or paper with ease in 
times of stress or panic. Incidentally these two 
results of a central reserve svstem make borrowers 
more ready to confine their borrowings to the 
limits laid down by the central reserve institutions 
regarding bills they will discount. Borrowers find 



REDISCOUNTING OF COMMERCIAL PAPER 203 

that there are so great advantages in having com- 
mercial paper ><» secure that a great central bank 
will take millions of dollars of it even in a panic 
and that it can do this without endangering any 
of the units of the system dependent on the hank, 
that in the long run they do not complain of any 
restrictions laid on the form their notes shall take. 

There is Need for a Somewhat Similar 
System in the United States. 

The right of a central hank to issue credit notes 
is a study by itself. The writer- of these pages 
<1<> not say that an asset currency founded on com- 
mercial paper is necessarily a happy solution of 

ii- of our financial problems in this country. It 
i- simply interesting to note the results of such a 

3tem where it is practiced on a Large scale 
abroad. The United States i> a far Larger ami 
newer country than are the foreign nations whose 
banking we have examined. Moreover, the de- 
mands <>n the capital employed are much more 
extensive and for Longer periods of time, a- a rule, 
than are the demands on foreign capital in Eng- 
land, France or Germany. Whether we are in a 
position t<> maintain a Large asset currency suca — 
fully i- a question. It i- evident, however, that 
the closer association we can have between the 
reserves of banks the better. Clearing bouse 
organizations arc doing much t<> wield the reserves 

the clearing-house hank- a- one. We need, bow- 

r, a considerably more extended bond than we 



202 COMMERCIAL PAPER 

have, one which will not only draw together the 
reserves of national banks in one city, but a some- 
thing which will bind together, if not for unified 
action at least for unified purpose, the reserves of 
all central reserve cities in the country. Nothing 
can bring about the best possible banking so quickly 
as this. 

Our Bank Reserves Must be Bound 
Together. 

AVe in the United States have grown to fear, 
with some reason, the giving of great money power 
to one group of men. We are also constantly hin- 
dered in economic endeavor bv the shifting of 
political power from one group of men to another 
within comparatively short terms, and by the inter- 
ference of men raw at their work, however good 
they may be. Our system of bank units at the 
present time is not much worried by political inter- 
ference ; but there is enormous competition be- 
tween these units and when one does pull out a 
little ahead of the others it is not apt to lose the 
spirit of the competition to play the part of Good 
Samaritan to the rest. Consolidation of banks 
will not affect this difficulty, for it is a principle 
that the more consolidation there is, the keener 
competition there is also. What must take place 
is an arrangement for an organization to bind to- 
gether the reserves of the banks of the country 
which will be absolutely out of politics, which can- 
not have money-making as its prime motive and 



REDISCOUNTING OF COMMERCIAL PAPER 203 

which shall be in the hands of men who shall 
regard it as the greatest honor to be in charge and 
who shall be acknowledged as at the top of the 
banking profession. It is needless to say that 
these men must be above the suspicion of wielding 
any power pur in their hands for the benefit of 
their own interests. This, we believe, the Aldrich 
Plan is arranging and we have great confidence in 
the plans for this end of the American Banking 
Association. 

An Asset Currency Has Many Dangers. 

There have been many schemes for attaining 
this sought for end, most of them leaning toward 
the use of an asset currency to be used for redis- 
counting commercial bills. A few of them, not- 
ably the plan outlined by Mr. Aldrich, are to be 
examined. It should be borne in mind, however, 
through any discussion of the subject of currency, 
that being given a certain population and a certain 
coinage system, which once fairly distributed ls 
sufficient to conducl easily a norma] business, the 
problem i- r«> maintain that coinage in the correct 
ratio t<» the population engaged in business and to 
the business don.-. The solution of this problem 
means firstly, that money musl be mobile and that 
hoarding of any large sums of money will be done 
away with. The doing away with the tying up of 

in will prevent many panics and will mitigate 
the in- - re panic-. It will not prevent the 



204 COMMERCIAL PAPER 

rise and the fall of money rates within compara- 
tively narrow limits and it will not permit facile 
business when naturally very high or inflated 
prices occur, nor will it prevent panics arising 
from an extension of credit. If a currency system 
is desired which will permit facile business on a 
basis of exceptionally high prices, or that will pre- 
vent such prices momentarily, a step further must 
be taken. But if this step is taken it must also 
be borne in mind that the path followed must be 
one which will protect the traveller from too sud- 
den a fall. It must be remembered that com- 
modity prices adjust themselves ultimately to the 
credit supply, not of the nation but of the world, 
and that a high level of commodity prices, which 
is equalized on the other side by a currency 
founded on those commodity prices at their high 
level, when those commodities represented at an 
earlier stage a krwer level in gold, is apt, when a 
change in the condition of credit occurs, to take 
a sudden decline, thus greatly disturbing the cur- 
rency of the country. It is the opinion of the 
writers that a reasonable variation of money rates 
in a community which has and uses a supply of 
coin suited for its normal business needs is not 
to be avoided. If at times exceptional work is 
called for on the currency of a nation it may be 
well to provide for an artificial assistance; but 
that assistance must be used as a powerful drug 
in the hands of a skilful physician. The patient 
must not be allowed to be dependent on it and its 



REDISOOUNTING OF COMMERCIAL PAPER 205 

use must be stopped the instant the patienl can 
gel along without its aid. 

The Rediscounting of Commercial Paper 

is One of the Chief Duties of a 

Central Reserve System. 

Any ('(Mitral reserve system must exist largely 
to discount commercial paper. There can be no 
better reserve for a bank than the best commer- 
cial paper, provided there is any sort of a discount 
marker available. To encourage banks to use 
commercial paper at least as their secondary re- 
serve on a large scale would aid commercial enter 
prise greatly, would strengthen the position of 
the banks, would enable them to earn more money, 
ami, last but not least, would put a stop to season- 
able periods of great speculative activity in the 

•k market. In fact, Mr. Aldrich said when 
introducing his plan for a central reserve associa- 
tion: "The suggestions submitted herewith are the 
result <>t' years of study which I have given tin's 
Bubject and are formulated in the light of Hie 

at ma-- of information which the (monetary) 

omission has gathered respecting both our own 
banking system and needs and the experience and 
foreign countries." 

There is Need of Liberalizing the old 
National Bank Law. 

"It" I ;nii right in believing that the present 
law is obsolete and of this there can ho no doubt 



206 COMMERCIAL PAPER 

— there is, then, no room for argument in regard 
to the necessity for modernizing the law. Assum- 
ing such to be the case it must be our aim to 
accomplish this result with as little disarrange- 
ment as possible. It should be our aim to liber- 
alize the present national-banking act and to add 
to it such features as are deemed essential, rather 
than to formulate any plan which will fundament- 
ally change our present system." 

Under This Law Reserves are Much 
Too Scattered. 

"In the light of our experience it is obvious 
that one of the principal needs is to find some 
method for the unification of our present banking 
institutions into one comprehensive system. In 
other countries we have found that reserves are 
concentrated and used freely in any direction 
when needed. Under our faulty system reserves 
are so scattered as to be unavailable in time of 
trouble either for purposes of assistance or de- 
fence." 

The Old Law Does Not Combine Interests. 

"The result of our law has been to create a 
banking system made up of a great number of 
isolated units, each working within a limited cir- 
cle and each of necessity governed by its own im- 
mediate interests without reference to what would 
be for the greatest good of all." 



REMSCOUNTTNG OF COMMERCIAL PAPER 207 

Too Much Moni - Into 

as. 

Mr. Aldrich then wont on to say that, although 
much is admirahle in the banking - 3t< ms of 
Europe, no one of them is applic - m- 

trv. 1 1 

bank note circulation and pointed out the work- 
- theory in this regard. "In addition," 
he said, "to that. - a mr.ro scientific note issue) if 
we ran aid in creating a discount market in this 
country similar to the discount market- in Euro] 
- that the most liquid portion of our hank funds 
will not of nee. ssil such a lai s 

the mak 

. but will, instead, he 

available for the needs of commercial busim ss, 

adened our banking meth< - 

ring incalculable benefit to the commercial 

life of the country." 

Under the Old Law There is no Beady 
Method of Rediscounting. 

d hank- Lot been allowed 

is, se - an 

sement Whether or i 

they may end< - when tl 

- 11 it. : - >pen <jt - At the p - 

tin • . . the only n they bave for rais- 
tly much • 

mch endorsement, usually 



208 COMMERCIAL PAPER 

without the limitation of "without recourse." 
Banks rediscount (a) through their larger corres- 
pondents., usually giving their endorsements, or 
(b) by reselling without their endorsement the 
paper they have bought to the note broker from 
whom they originally purchased it. As brokers 
wish to make at least a small profit through the 
service of rediscounting, banks find it as a rule a 
cheaper practice to rediscount through their cor- 
respondents. This occasionally, at least, bears 
hard, too hard, on the correspondents of country 
banks in central reserve cities in some particular 
sections of the country. 

The Recent Law Permitting an Asset 

Currency Was But a Temporary 

Measure. 

A law permitting certain rediscounting through 
a credit currency was passed after the recent panic 
of 1907; but it was not meant to be more than a 
momentary measure. It allowed the use of receiv- 
ables only, as a basis for credit notes, and it was 
not very far reaching in its effect, was complicated 
in its action and did not hold out any great 
inducement to the national banks to prepare to 
take advantage of it, as it did not combine the 
reserves of the country. At best, as Mr. Victor 
Morawetz says in his "The Banking and Currency 
Problem in the United States," "the act is a 
measure to mitigate money stringencies and panics 
after the event." No great preventive measure 






REDISCOUNTING ov OOMMERCIAL PAPEB 209 

is incorporated in the act. Mr. AJdrich's plan 
es much further in thai it aims not only al com- 
bining the reserves of the country bul al founding 
an organization for the issuing <A' an asset gur- 
rencj based on commercial paper. 

It is an [nnovatioD in r rhis Country to 

Save Commercial Paper as a 

Basis for ( lurrency. 

It must be remembered that we bave had an 
asset currency in working operation for many 
years. Our present bank aotes founded on gov- 
ernment bonds arc pari of an asset currency. The 
introduction of commercial paper as a basis for 
such a system is, however, a great innovation. It 
makes the currency very elastic, whereas an asset 
currency based on government bonds is nearly 
inelastic. Commercial paper in itself, except in 
time of war, is, if properly used, undoubtedly safe 

a l»;i-i- for such a currency. France ami (Jer- 
manv are now using it as such with success. The 
9 stem under which it i> planned tin's country 
shall operate it- currency has adapted very well 
commercial paper ,-i- it exists with us as a basis 
for circulat ion. 

Briefly the plan that Mr. Aldrich originated is 

lows. Ihi- summary is taken from "Sug- 

Plan for Monetary Legislation" by Hon. 

k Nelson W. Aldrich, and "The Aldrich Currency 
Plan Interpreted," ,-i pamphlet sent mil by the 



210 COMMERCIAL PAPER 

Continental and Commercial National Bank of 
Chicago. 

Section 1 proposes to charter a Reserve Associa- 
tion of America which will be the principal fiscal 
agent of the United States Government, with a 
capital of $300,000,000 approximately, with a 
fifty year charter and with head offices at Wash- 
ington. There are to be fifteen Reserve Associa- 
tion branches in the country. 

Section 2 provides for the ownership of the 
stock of the Reserve Association of America by 
national banks only and in the proportion of one- 
fifth of their capital only. This provision denies 
the privilege of dominance by any special interests. 

Section 3 provides for the earnings of the Re- 
serve Association to be distributed up to five per 
cent to the stockholders and to a surplus fund of 
the Reserve Association and to the Government. 

Section 4 provides for the grouping of all 
national banks owning stock in the Reserve Asso- 
ciation, by single units, first into local associations 
of at least ten in number and after this by local 
associations into fifteen districts. 

Section 5 provides for an equitable election of 
managers of the local associations. 

Section 6 provides for an equitable election of 
directors of the different fifteen branches of the 
Reserve Association, one branch to be in each of 
the fifteen districts formed from the local associa- 
tions. 

Section 7 provides for an equitable representa- 



REDISCOUNTING OF OOMMERCIAL PAPER 211 

tion on the board of management of the Reserve 
^Lssociation consisting of forty-five members of all 
of the local associations, of the government, and 
of the various industrial activities of. the country. 
This section also provides for non-political inter- 
ference. 

Section s provides i'ov executive officers of the 
Reserve Association. 

Section 9 provides for executive officers of the 
fifteen branches. 

Section 10 reads as follows: — 

"Any member of a local association may apply 
to that local association for a guaranty of the 
commercial paper which it desires to rediscount at 
the branch of the Reserve Association in its dis- 
trict. Any such hank receiving a guaranty from 
a h>cal association -hall pay a commission to the 
local association, to he fixed from time to time by 
the board of directors of that local association. 
The guaranty of the members of the local associa- 
tion i]i the event of loss -hall he nici by the mem- 
berg of the local association in the proportion to 
the ratio which their capital and surplus bears to 
the aggregate capital ami surplus of the local asso 
ciation, and the commission received for such 
guaranty, after the payment of losses and expenses, 
shall be distributed among the several hanks of 
the local association in the same proportion. A 
local association -hall have authority to require 
additional security from any bank offering paper 



212 COMMERCIAL PAPER 

for guaranty, or may decline to grant the applica- 
tion." 

"The total amount of guaranties by a local asso- 
ciation to the Reserve Association shall not at any 
time exceed the aggregate capital and surplus of 
the banks forming the guaranteeing association." 

Section 11 provides for fair treatment by the 
Reserve Association of every stockholder, also for 
the deposit of Government money with the Asso- 
ciation, for the non-payment of interest on deposits 
and for the discounting of notes and bills of 
exchange arising out of commercial transactions 
for and with the endorsement of the bank having 
a deposit with the Reserve Association. "Such 
notes," this section says, "must have a maturity 
of not more than 28 days and must have been 
made at least 30 days prior to the date of redis- 
count." Other provisions also safeguard the redis- 
counting of such paper. 

"The Reserve Association may also rediscount," 
this article says, "for any depositing bank, notes 
and bills of exchange arising out of commercial 
transactions having more than 28 days to run but 
not exceeding 4 months to run, but in such cases 
the paper must be guaranteed by the local associa- 
tion of which the bank asking for rediscount is a 
member." 

This section also provides for the discounting 
of the direct obligation of a bank when covered by 
collateral under certain conditions. 



REDISOOUNTING OF OOMMER( 1AL PAPER 213 

It also provides for a uniform rate of discount 
throughout the United Si arcs. 

The 3ectioi als provides for the purchase of 
certain commercial paper from its depositing 
national banks when such paper has not more than 
90 days to run, when such paper can properly be 
called prime paper as it is known in England, for 
example, and when such paper is endorsed by the 
selling bank. Such purchases are to be made not 
much at the instance of a depositing bank 
as of the Reserve Association. They are to take 
place only, therefore, when the condition of the 
Reserve Association is especially strong. 

Power is also granted the Reserve Association 
to purchase United State- Government bonds and 
obligations of the United States, of S j t c> and of 

tain for _ governments of not over a year to 
run, also to deal in gold or t<> contract for loans 

gold, also to purchase certain bill- of exchai 
having not more than 90 days to run. 

Section 12 provides for transfers of balances of 
the Association by tin- Association. 

S Jtion 13 provides for the granting of flic right 
to national banks to accept, that i- to endorse, 

tain bills other than bills they themselves <>wn. 

S don 14 provide- for reports by the Associa- 
tion to the Comptroller of the Currency. 

S jtion 15 provides for the issuing of legal 

tern b ernmenl bonds, Becond 

nmercial paper. The Reserve Associa- 

against such commer- 



214 COMMERCIAL PAPER 

cial paper as has been described, provided they are 
covered to the extent of at least one-third by gold 
or other lawful money, the remainder by United 
States bonds or by bankable commercial paper. 
For the first $100,000,000 of such notes based on 
commercial paper and beyond an amount based 
on government bonds already provided for, the 
Reserve Association shall pay a tax to the gov- 
ernment of 3% per annum: for the second 
$100,000,000 a tax of 4% per annum, for the 
third $100,000,000 a tax of 5% per annum and 
for all above $300,000,000 a tax of 6% per 
annum. 

There are Views Opposing a Greatly 
Fluctuating Currency. 

President Hadley of Yale in his "Economics" 
says in a review of credit, note issues and a central 
bank : — 

"The concurrent increase of credits (arising 
from the discounting of notes and subject to 
check) may continue until the liabilities of banks 
become disproportionate to their reserves. When 
the public perceives this there is a sudden shock 
to confidence and a withdrawal of accommodation 
which causes far greater distress than would have 
resulted had the facilities of payment by credit 
been less elastic at the outset." 

"This danger is very much greater when bank 
credit takes the form of notes instead of checks. 
^Credit given in the form of a deposit account is 



REDISCOUNTING OF OOMMERdAL PAPEE 215 

exhausted in a short time, because the checks 
drawn against it soon come hack to a hank for 
redemption. But credit in the form of notes nniv 
remain outstanding for an indefinite period. 
These note- may change hands a thousand times 
before returning to the bank.* It' prices begin to 
increase ; from any cause whatsoever, this increase 
furnishes a ground for an enlarged issue of notes 
on the same physical volume of business. This 
goes on until prices and currency both become so 
inflated that people see the danger and suddenly 
refuse to accept notes as the equivalent of money. 
If the n<>te issue is very large in proportion to the 
coin available such a change of sentimfent may 
come at almost any moment." 

President lladley goes on to point out that 
hank note inflation doc- not always lead to serious 
disaster. Careful provision for note issue, he 
says, aids it- usefulness greatly; but he adds: 

"No method of organization of the banking sys- 
tem has been devised which will avoid these evils. 
Local banks and centralized hank- have alike been 
subject to them." 

"It i- urged/ 5 President Hadley says, "both 
inst the English and American systems that 
they are based on no philosophical or economic 
principle. Each of them limit- the issue of hank 
notes* by a somewhal arbitrary line. Enstead of 
furnishing an elastic currency that will expand 
• with the demands of business, they 
furnish a highly inelastic one. In England there 



216 COMMERCIAL PAPER 

is no available means of increasing the circula- 
tion except by suspending the Act of 1844. It 
has been pointedly said that the English Bank Act 
is of rise only when it is rendered inoperative. 
What is done in England by suspension of the 
Bank Act is done in America by the issue of clear- 
ing house certificates in virtual disregard of the 
National Banking Law. Each of these things 
represents a breach of the statutory principle, 
justified only by a public emergency/' 

"Yet the necessity of thus suspending limita- 
tions in an emergency does not prove that the limi- 
tations themselves are unwise. The most im- 
portant function of bank note issues, in a country 
which enjoys the benefit of the check and clearing 
house system, is to provide a reserve for emer- 
gencies. If we limit note issues in ordinary times 
we have a reserve power upon which we can fall 
back in extraordinary times. The objection to 
unlimited bank note issues is that they leave us 
no such reserve to fall back upon. If the cur- 
rency is made thoroughly elastic in years of con- 
fidence there is no power of stretching it further 
in days of doubt. If the check system alone has 
been overstrained, a bank that has the power to 
issue additional notes can ease public confidence. 
But if the public demand for the use of notes as 
well as checks has been supplied to the utmost, we 
have no further reserve at our disposal. For this 
reason an unphilosophical limit to note issue is far 
better than no limit at all.* To prevent the recur- 



REDISCOUNTING OF COMMERCIAL PAPEB 217 

rence of experiences like those of L825 in Eng- 
land, or L857 in the CTnited States, the Important 
thing is to have a limit to note issue and to have 
it low enough.* Paradoxical as it may appear, 
the all important thing is that the bank note cur- 
rency should not meet the wants of business in 
ordinary times: that it should not be sufficiently 
elastic at such times as to be unable to take addi- 
tional strain in times of emergency." 

The Aldrich Plan is Xew Practice 
for This Country. 

President Hadley did not know of the ten- 
tative Aldrich Plan when he wrote the foregoing. 
It is interesting, nevertheless, to apply his theories 
as to bank note issue in connection with the 
Aldrich plan. Mr. Aldrich has carefully limited 
the use of credit notes and he has taxed these notes 
erely, which is in itself a tremendous safeguard 
inst over expansion from them. The Aldrich 
plan, however, — goes considerably further than 
President Hadley states a credit currency should 

Mr. Morawetz has Presented Still 

Another View. 

"The Banking and Currency Problem in the 
United 3 -." ly Victor Morawetz, develops -till 
other points of view of centra] banking in this coun- 

. Mr. Morawel - primarily that we must 



218 COMMERCIAL PAPER 

provide for the largest volume of bank credits that 
we can and yet have them on a safe basis. We 
must not do this, he says, by increasing reserves 
close to the amount of actual deposits, but by devis- 
ing a system "that will permit of the largest pos- 
sible expansion of bank credits consistent with 
safety." "It is obvious/' he says, "that our cur- 
rency question is really a question of bank credits 
and bank reserves. The problem is, while pre- 
venting any unsafe expansion of credits or the 
issue of any unsafe currency, to find a way (1) 
to avoid a depletion of bank reserves and the con- 
sequent large reduction of bank credits in times 
when lawful money is withdrawn to pay taxes, 
etc., and (2) to enable the banks in times of great 
business activity to expand their deposit liabilities 
and their loans and discounts and also adequately 
to increase their reserves of lawful money." 

"While there is no practical way of increasing 
the aggregate amount of lawful money in the coun- 
try except by digging gold out of the ground or 
by importing it from abroad, there is a way of 
rendering available as bank reserves part of the 
gold and other lawful money already in circula- 
tion among the people. This result •can be brought 
about through the issue of bank notes, which are 
merely promissory notes of the banks to pay law- 
ful money to bearer on demand." 

Mr. Morawetz suggests as a solution of a diffi- 
culty which he points out in the reserve require- 
ments of national banks, that the banks be required 



REDISOOUNTING OF COMMERCIAL PAPER 219 

to keep in cash on hand in their own vaults con- 
siderably larger minimum reserves against deposits 
of other banks than the requirement now calls for, 
and against other deposits a smaller reserve than 
is now required. 

"There is no country in the world/' Mr. Mora- 
wel _ n to siy, "where the volume ^\ currency 
in circulation and the demand for bank credits 
fluctuate more widely than in the United Stato 
In the United States there is no way of regulating 
the supply of bank credits and of holding part of 
the potential supply in reserve for periods of finan- 
cial stringency. Consequently, nearly always there 
is either an over abundance of money (meaning 
credit which the banks are willing to lend) or a 
money famine." 

"The leading nations of Europe have learned 
by experience that * the only practical way of 

Emulating the general expansion of hanks credits 
30 as r " provide for exceptional conditions, a- well 
a- for the ordinary requirements of commerce* is 
t<» invest boards of experienced men with some 
measure of power to control the expansion of bank 
credits, ami in particular with the power t<> regu- 
the issue of bank-note currency."' 'This con- 
trol can he exercised by the central hank in the 
following manner: — 

acting <-i- .-i hank for the <li>c<>uni of 
mercial paper. 

issuing its nolo, the centra] hank can 
prevenl a withdrawal of bank reserves for use a- 



220 COMMERCIAL PAPER 

circulating currency and a consequent financial 
stringency, and by diminishing the volume of its 
outstanding notes it can check over expansion 
when the occasion for the issue of the notes has 
passed" This last feature is very important and 
should not be overlooked. A permanently suc- 
cessful system must be able to contract the cur- 
rency when the demand is below normal as well 
as to expand it when the reserve is above normal. 

Our Aim Must be to Mitigate and 
to Prevent Panics. 

The currency system which this country is ulti- 
mately to have will undoubtedly be the composite 
views of many men all harmonized and adjusted 
to the environment they are especially planned to 
fit. It will probably be some years yet before we 
have perfected our system. Whatever form our 
banking laws and customs will take, however, they 
must primarily aim at cessation of panics. To 
mitigate and, if possible, to do away with these 
must be their chief purpose. 

All Financial Crises Show Many 
Similar Characteristics. 

All financial panics have much in common, both 
in their causes and in their courses. The key note 
to practically all of them has been extension of 
credit to the point where stretching can no longer 



REDISOOUNTING OF COMMERCIAL PAPEE 221 

occur. The consequent sudden retraction lias 
brought "ii the severe stress for which so many 
have periodically suffered, especially during recent 
years in the United S tes. Beginning with the 

first great panic of the world in the nineteenth 
century, that of England in 1825, we see much 
that is alike in all. The panic of 1825 came at 
the height of prosperity. Everybody had been 
well-to-do, all seemed rosy; but underneath a 
genera] extension of credit had been going on: 
there had been much speculation, much pyramid- 
ing of investments. Suddenly, in the fall of 1825 
the crash came. Credit was restricted and prices 
everywhere fell. "In six years," says Mr. IT. M. 
Hyndman, in "Commercial Crises of the Xine- 

ath Century,!' "no fewer than seventy provin- 
cial hanks failed." Matters adjusted themselves 
after a time, but n<>t till very serious results had 

•irred. As the readjustment took place the 
most noticeable • factor in the situation was the 
glut of commodities on the market. 

Recent Panics Have Been Like 
Earlier Ones. 

The panic of l x -')<». when, ;i- Mi*. ETyndman 

9, "the whole of the Amerie;in hank- suspended 

Bpecie payments, and eventually, in l v -*;7. 618 
hank-, and in 1 839, no fewer than 959 banks 
failed." was very much like thai of L825 iii Ei 
land. The same forces were at work though on 



222 COMMERCIAL PAPER 

a somewhat changed environment. The crisis of 
1847 was brought on abroad by the failure of crops 
and the consequent exit of gold for foreign grain. 
In the United States it came from excessive spec- 
ulation and imperfect banking. The later crises 
of the century and especially the crisis of 1857, 
that of 1882 and of 1903 together with the panic 
of 1907 showed much that was similar to these 
earlier periods of business upheaval. In all a 
credit that was unequivalent to the real business 
needs of the nations involved was the prime cause. 

Financial Crises May Arise From the 

Granting of Too Little or Too 

Much Credit. 

Panics may 'come from the allowance of too 
little credit and from the allowance of too much. 
Usually, however, owing to the general optimism 
of mankind, a panic comes from the granting of 
too much credit. Often a general extension of 
credit is followed by a sudden swing of the pend- 
ulum in the other direction, bringing as great a 
retraction of credit as there has been an extension, 
and thus intensifying the acuteness of the situa- 
tion. To prevent panics and to mitigate them 
when they have arisen we must have a credit flow 
which will rise and fall with the true business 
demands of the nation, following these needs when 
they advance on a firm basis, and restraining them 
when they go beyond their depth. An asset cur- 



REDISCOUNTING OF COMMERCIAL PAPER 223 

rency based on commercial paper, which represents 
a certain Level of commodity prices, must see to 
it not oihly that ir keeps pace with those commod- 
ities when their price represents true value in the 
credil supply of the world, but such* an asset cur- 
rency must also see to it that it does not follow 
commercial paper through a level of prices for 
commodities which, when weighed against the 
credit supply of the world, are sure to prove over 
heavy. There must also be a ready method for 
such an assel currency to contract if it finds it is 
overstepping itself in its pursuit of true com- 
modity pric 

\Yo Should Introduce Innovations in Our 
Banking Very Guardedly. 

Any change in our banking methods should 
always be approached with the greatest fore- 
thought and care and any change to he made 
should l»c made slowly. The writers of these 
pages have tried to show that our firsl need is to 
create a central discount market for commercial 
paper. We have tried to prove that some central 
reserve association of bankers should always be 
given some powers over the reserves of national 
banks, so that it' one section of the country has 
much money it may readily ho placed at the dis- 
posal of the pari where a stringency exists. The 
limit- of the investments of this association should, 
• \cry stringent that only the 



224 COMMERCIAL PAPER 

strongest borrowers shall have access to its aid. 
Money made use of by the association should count 
as part of the reserves of the banks owning it. 

A Union of Eeserves and an Asset 
Currency are Separate Problems. 

The question of note issue based on commercial 
assets is an absolutely different proposition from 
that of a union of reserves. If we can improve 
our banking and increase the confidence of people 
in it we shall not need very often an asset cur- 
rency. It is the hoarding of money both by indi- 
viduals and by banks that creates the call for such 
a currency. Money is tight in the crop moving 
periods. This is a perfectly natural situation and 
is not so very terrible an affair provided it is not 
allowed to cause a panic every time the crop mov- 
ing season arrives. To have a necessarily some- 
what higher rate in the fall than in the summer 
for money transformed into a jump of five or ten 
per cent in rates is not natural, however. That 
this happens is largely a matter of manipulation, 
largely of our fear of conditions. An asset cur- 
rency would probably prevent it; but an asset 
currency has some dangers which we should if 
possible avoid. Probably a combination of the 
reserves with a continued confidence in our bank- 
ing system and in our mercantile finance, with 
especial reference to commercial paper, would do 
away with much of the need of an asset currency. 



KKDlsUH X TIM. OF COMMERCIAL PAPER 225 

In fact, by a more general study by hankers of 
fundamental business conditions and by increas- 
ing the genera] respect for our commercial paper 
so that there will be a market for.il abroad when 
our own reserves are exhausted, the Issuance of 
asset currency could be avoided. 



CHAPTER VII 

HOW INTEREST RATES MAY BE FORECASTED 

UP to within the last few years economists 
have been divided into two "schools," 
when discussing the course of future in- 
terest rates. One school has considered simply 
the element of time, believing that there is a 
periodic rhythm in the course of rates and that 
a period of low interest rates comes approximately 
every so many years. They believe that this 
period is — within a certain number of years — 
again followed by a period of high interest rates, 
and so on. Believers in this theory, however, 
disagree as to the length of the periods. Although 
all unite that there are major periods of approx- 
imately twenty years, the length of the average 
business generation, yet they differ as to the dura- 
tion of the minor periods, which, of course, are the 
ones in which the country banker is interested and 
which usually last only from one to five years. 
The fact that students differ so widely as to the 
duration of the said periods of time is one reason 
why we believe they are wrong in their assump- 
tions. In fact, we strongly believe that there is 
no economic basis for the statement that interest 
rates must rise and fall according to any period 
of time. 



INTEREST HATES FORECASTED 227 

The Intensity of Business Periods 
Should be Examined. 

The other school of thought bases its prognos- 
tications on the theory that investments in interest 
rates are due only to the intensity of the business 
period ; — that is to say, that interest rates will 
continue to increase until they reach a certain 
height, when they will then decline. They believe 
that the decline will continue until rates reach 
a certain low point, when they will again begin 
t<> increase. Their reasons are very plausible, 
claiming as they do that the high point is reached 
when rates exceed the value and usefulness of the 
money, and the low point is reached when the 
rate is too small to pay for the trouble involved 
in the lending. On analyzing these reasons, how- 
ever, they will be found to be very superficial, 
the value is an indeterminable quantity, and 
-upposed to be dependent upon supply and de- 
mand. 

Business Intensity Alone Will Not 
Forecast Rates. 

It might be -aid that the men who believe that 
rything is regulated by supply and demand 
also belong r<» thia school; for the terms "supply" 
and "demand" are trery indefinite and mean noth- 
ing of themselves. In fact, if one of these ''sup- 
ply and demand men" [fl asked to name the caiM 
or the causes of the demand, he 



228 COMMERCIAL PAPER 

immediately places himself directly in one of 
these two "schools" of thought. Therefore, it 
may fairly be said that, up to the present time, 
most students of fundamental business conditions 
have been divided into these two schools, one 
basing its prognostications on the factor of time 
and the other on the factor of intensity, or, in 
this case, interest rates. Neither of these two 
schools of thought has, in our opinion, true eco- 
nomic reasons for its theories, and this doubtless 
is why the said theories have failed to demand 
more serious consideration. 

Eates Depend on the Duration of the 
Intensity of Business. 

In more recent years, however, there has devel- 
oped a third school of thought which bases its 
prognostications on what is known as the "area 
theory." This area theory considers both the 
factor of time and the factor of intensity, or rates. 
Their study of future interest rates is based on 
the product of these two factors of time and rates, 
or in other words, on the area consumed. 

The Area Plan Best Represents 
Business Conditions. 

In short, this new school draws an oblique line, 
with a slope based on the increase, in the nation's 
volume of trade, the fluctuation of which may be 
determined by a PT" in Professor Irving Fisher's 



INTEREST RATES FORE( A.STED 229 

formula, PT = MV + M'Y'. 1 Starting at a 
time when the business of the country is practi- 
cally normal, as early in L903, actual business 
conditions may be plotted from month to month. 
This gives certain areas below ami above this line 
of normal growth, which line i- based on "PT," 
and these areas are designated on the annexed 
]>l<»t as A, Bj C, and D. In order to plot busi- 
ness renditions from week to week, the following 
twenty-five subjects arc considered and combined 
under twelve headings: (1) Building Construc- 
tion, (2) Money in Circulation, (3) Comptroller's 
Reports, (4) Loans of the Banks, (5) Cash held 
by Banks, (6) Deposits of Banks, (7) Surplus 
rves of Banks, (8) Total Bank Clearings, 
i 9 ) Bank Clearings excluding New York, (10) 
Stock Exchange Transactions, (11) New Secur- 
ities, (12) Business Failures, (13) Labor Statis- 
tics, i 14) Imports, (15) Exports, (16) Balance 
of Trade. ( 17 J Gold Movements, (18) Foreign 
Money Kates, (19) Political Factors, (20) Pro- 
duction of Gold, (21) Commodity Prices, I 22 ) 
Crop Conditions, and [ron Production, (23) Rail- 
road Earnings, (24) [die Car Figures, (25) Re- 
ligious and Social Statistics. These twelve head- 
ings are: 

MERCANTILE CONDITIONS. 
1. Immigration :;. Failu 

■i. New Building i. Bank ( tearing 

"The Purchasing Power <»f Money," by rrvlng Fisher, pub- 

Miii.-ni < ... (M \iiiuimt of monej in circulation; 
M \iii..i;].t «,t individual checking deposits; V and V are there- 
ocities of these factors; 'I' volume of trade; and F The 
price index.) 






230 COMMERCIAL PAPER 

MONETARY CONDITIONS. 

1. Commodity Prices 3. Foreign Money Rates 

2. Surplus Reserves 4. Domestic Money Rates 

INVESTMENT CONDITIONS. 

1. Condition of Leading Crops 3. Political Factors 

2. Railroad Earnings 4. Stock Market Conditions 

After obtaining such data each week, the latest 
figures on each subject are reduced to index 
figures, on the same principle that the London 
Economist reduces the prices of a number of dif- 
ferent commodities to one common index figure. 
This index figure is a sort of "barometric index/' 
showing each week the general business conditions 
throughout the entire country. By systematically 
plotting each week this barometric index number, 
one has the outline of a plot that shows graphic- 
ally general business conditions as determined by 
fundamental statistics. 1 

Mechanical Law is Applicable to 
Business Conditions. 

In the plot reproduced on page 71, the large 
black areas — A, B, C, and D — are the result of 
such an outline obtained in such a manner and 
representing the past few years. This is known as 
a Composite Plot of Business Conditions. This 
Composite Plot shows first, the business conditions 
existing today compared with any other time since 

1 See "Business Barometers" by Roger W. Babson. 



[NTEREST K.\ TES FORE( ASTED 231 

L902; and, second, based as it is upon the law 
of "action and reaction being equal when the total 
force involved is considered," it indicates how 
much longer present conditions are to last. 

The Area Plan Will Forecast Rates 
Better Than Any Other. 

This Composite Plot, therefore, shows bankers 
and merchants the actual conditions existing at 
any given time, and, on the assumption that these 
areas tend to be equal in area, (not in shape), it 
aids one in forecasting future conditions by show- 

' whether (he next area may be expected chore 
or below the line of normal growth and about how 
long it may be before it will come. Of course, 
this third "school" simply combines the work of 
the two former schools, as those of us belonging 
to the third "school" consider both time and rates, 
in-read of simply one of these two factors. On 
the other hand, a little thought shows how reason- 
able this third theory is and how it automatically 
adjusts itself to conditions, the same as a governor 
"ii an engine. For instance, if rates increase 
20% above a normal, it is no1 reasonable to think 
that they will necessarily continue to go up until 
they reach the lasl previous high of sr ^, irre- 
spective "l" the time consumed; but it is reason- 
able to suppose that after rate- have had this 
increase of 20^5 for a period of three times aa 
long a- they held when selling at the previous high, 



232 COMMERCIAL PAPER 

which was an advance of 60 %, that they should 
fall. 

Bates Follow Changes in the 
Business Areas. 

In other words, the theory is that business con- 
ditions as a whole can continue with "the throttle 
one-third open" about three times as long as with 
the throttle wide open ; or, to word it another way, 
when conditions are trebly prosperous, they can 
so last only one-third the* period of time that they 
would if they were only moderately prosperous. 
This school believes that if the country should be 
willing to run along at a normal rate of speed so 
that the line for actual business would correspond 
with the line of normal growth, we should always 
have moderately prosperous conditions with a 
steady, slow advance. On the other hand, the 
higher that the line for actual business arises above 
the line of normal growth, the shorter length of 
time prices will remain high and conditions be 
abnormally prosperous. 

Any Special Business Study, Such as the 

Study of Rates, Must be Based on 

the Area Plan. 

The preparation of this Composite Plot of Busi- 
ness Conditions, however, is simply the first step, 
or the basis, of this most recent and hopeful work 
relative to forecasting interest rates. 1 After pre- 

lSee Irving Fisher's Standard work on "Interest." 



ENTEREST RATES FORECASTED 233 

paring this Composite Plot, the next step is to 
plot thereon a line representing the interest rate 
for prime commercial paper in order to ascertain 
the relation between interest rates and this Com- 
posite Plot. This work is now being done by a 
number of organizations in different pans of the 
country, and most wonderful results arc being 
"•brained. 

Such Studies Prove Definite Laws. 

The first work performed was to ascertain the 
relation of the commodity market to the < !omposite 
Plot, and ir has been found that the lowest com- 
modity prices have come when the depression areas 
have been about two-thirds consumed, while the 
highest commodity prices have come when the 
prosperity area- have been about two-thifds con- 
sumed. When forecasting the average of thirty- 
two active - - by the Composite Plot, it has 

en found that the high points of the stock market 
have come when the prosperity areas are about 
one-fifth or one-fourth consumed, and the low 
points of the stock market have come when the 
depression areas haw been about one-fifth or one- 
fourth consumed. 

Business Areas, ii' Properly Drawn, 
Forecasl Interest Bates Nicely. 

In the -Mine way the money market is now being 

. and the annexed ( iomposite Plot, above 

referred to, also contains a line showing the fluct- 



234 COMMERCIAL PAPER 

uations in prime commercial paper rates since 
1902. The following law will be found to be 
true. 

interest kates are highest when the period 
of prosperity is approximately consumed, and 
interest rates are lowest when the period of 

depression is about consumed that is rates 

reach their high point in the latter part 
of a prosperity area, when they turn, and 
continue to decline well into the depres- 
sion area, toward the end of which they 
again begin to advx\nce. when the prosperity 
area is shallow, rates will continue fairly 
firm for a much longer period of time than 
when the prosperity area is high and vice 
versa: but when the prosperity area is high 
and short, rates may suddenly increase to a 
very high point, and a money panic sometimes 

OCCURS. 

Study of the Composite Plot of Business 
Conditions is of Enormous Value. 

Heretofore, the bankers and business men have 
either followed one of the two above mentioned 
a schools of thought" or else guessed, and thus in 
most cases have found themselves mistaken. If 
the law above mentioned is true, hereafter the busi- 
ness man need simply to watch this Composite 
Plot each week, noting its development, and, by 
the use of the above mentioned law, know approx- 
imately when to expect a turn in interest rates. 



[NTEREST EtATES FORECASTED 235 

If the area develops slowly, he may know that it 
will be some time before interest rates will rad- 
ieally change, and he may base his eommitments 
in accordance therewith. On the other hand, if 
the prosperity area develops very rapidly, as was 
the case in L909, he may expect higher rates at 
any time and should plan his business on the 
sumption that there may he a money stringency. 
Thus, by watching the growth of this area from 
week to week, bankers, manufacturers and mer- 
chants may forecast with wonderful accuracy the 
probable course of money rates, giving due con- 
sideration of the seasonal fluctuations which have 
been most carefully deduced by Prof. E. W. Kem- 
mcrer, as follow.- : 

Seasonal Variations Must be Allowed For. 

The study, the results of which are here pre- 
sented, was made to throw light upon the regular- 
ity and the extent of the seasonal variations in 
question, and the degree to which our currency and 
credit system responds to them ; and to exhibit some 
■ heir probable results upon more general eco- 
nomic conditions. The study i< based upon the 
period from l v< .><> to 1908 inclusive, so far a- data 
have been found available. The statistical material 
giv( jured in pari directly from ( bearing 

House associations, in part from individual bankers 
and public officials, and partly also from govern 
menl reports and financial journals. 



236 COMMERCIAL PAPER 

The New York Money Market Has 
Five Periods. 

"In the consideration of the changes in the 
demand for moneyed capital in representative 
cities prominence is, of course, given to conditions 
at New York City. A study of the data for that 
city leads to the conclusion that there are five 
periods in New York's money market. Begin- 
ning with the opening of the year there is through- 
out January a rapid decline in the relative demand 
for money, making the last part of that month 
and the fore part of February a time of very cheap 
money. This easing up is attributed to the fact 
that the crop-moving demand for money in the 
West and South has spent its force, and that the 
cash is flowing back to New York. Among other 
causes mentioned is natural reaction after the 
heavy strain on the money market incident to 
January 1 settlements. 

The Second Period Begins in February. 

The beginning of the second period is put at 
about the middle of February, the relative demand 
for money advancing rapidly to a high level and 
maintaining it through the fore part of April. One 
source of this upward movement is found in the 
encouragement given to investment by the low 
interest rates and the high reserves of the former 
period. Another cause suggested is the increase 
in certain lines of trade activity which normally 



INTEREST RATES FORECASTED 237 

takes place at about this time of the year. The 
Great Lakes, the Mississippi River, and other in- 
land waterways are opened to traffic during tin's 
period, and railroad traffic is released from the 
incubus of cold weather and snow. 

The Later Periods are Well Marked. 

A third important seasonal movement is traced 
in a rapid decline from about the middle of April, 
ending with a very weak money market in June 
and July. The latter are hot summer months, 
comprising the vacation period and the period 
before the great crop movements of the fall. A 
fourth pori<»d is dared from the first week in 
August, when call rates begin their upward move- 
ment and when bank reserves, both in amount and 
in percentage to deposits, begin their decline. 
There is a continued tightening of the money 
market until about October. Of the increasing 
demand for moneyed capital during this period 
the principal can-.- is the call made upon the 
New York City banks by banks in the West and 
S nth for cash needed for crop-moving purposes. 
Idie lasi seasonal period in the New York money 
market date- from about the first week in October 
to the opening of the now year, and during tin*- 
period the relative demand for moneyed capital, 
while exhibiting many minor fluctuations, remains 

substantially the high level reached in the fore 
parr of October." 



238 COMMERCIAL PAPER 

Conditions in Different Parts of the 
Country Vary. 

Another phase of the subject is dealt with in 
an examination of the demand for money in one 
section of the country as compared with the de- 
mand in another. Professor Kemmerer finds 
"that throughout January money in Chicago, rela- 
tive to that in New York City, is cheap. Ex- 
change rates on New York are high and there is 
a considerable movement of cash from Chicago 
to the eastern states, particularly to New York 
City, where it can at least earn the 2 per cent 
paid by banks on bankers' balances. From the 
last of January to the fore part of March the 
demand for money in Chicago, relative to that in 
New York, rapidly rises, owing to the anticipated 
and actual opening of navigation on the Great 
Lakes and to the spring needs of the western 
farmers. A decline comes in Chicago's demand 
for money from early in March till late in May, 
the demand being comparatively small from then 
until the fore part of July. About the first of 
the latter month the relative demand for money 
in Chicago begins to rise, advancing rapidly until 
early in September, and then maintaining a high 
level until the fore part of November. During 
the last six or eight weeks of the year, the crop- 
moving demand having to a large extent subsided, 
the relative demand for money is stronger at New 
York City than in Chicago. Exchange rates in 



INTEREST RATES FORECASTED 239 

Chicago on N*ew York rise and cash moves east- 
ward." 

Bank Reports Should be Constantly 

Examined. 

Aj3 a cheek upon the plan outlined it is desir- 
able to study the Comptroller's Reports as issued 
about every two months, and the New York Bank 
Statements as issued weekly. When using these 
Comptroller's Reports and Bank Statements, the 
following tentative general rules may be con- 
sidered. During a period of prosperity: 

(1) When the Loans of the Comptroller's 
Reports exceed the Deposits by more than about 
. a period of higher money rates may be 
expected. 

When the Loans of the Comptroller's 
Reports Increase at a greater rate than the De- 
posits, higher money rates may be expected. 

When the ratio of the Reserve to Net 
Deposits in the Comptroller's Reports falls below 
--' < or thereabouts, higher money rates may he 
expected, and the condition is more overstrained 
it this occurs during the fall of the year. 

When the Deposits of the New York 
Bank Statement decrease so as to equal the Loans, 
higher moi is may be expected, and if this 

continues, the situation i- serious. 

When the Surplus Rec ;' the Now 

5Tork Ban S emenl remains abnormally low 



240 COMMERCIAL PAPER 

for a considerable number of months higher money 
rates may be expected. 

The Composite Plot Can be Bettered. 

Of course, this entire work is in its infancy at 
the present time. The Composite Plot herewith 
annexed is simply based on comparatively few 
subjects, while a great many more subjects should 
be included. It also is a debatable question 
whether or not the subjects are properly weighted 
and combined. The location of the line of growth 
will also always be a source of dispute and subject 
to revision. Nevertheless, it is becoming uni- 
versally believed that the fundamental principle 
underlying the Area Theory is sound and, as soon 
as a Composite Plot can be made to represent con- 
ditions truly, interest rates can be forecasted with 
wonderful accuracy. 

The Area Theory Must be the Basis 
for Much Investigation. 

In closing, therefore, we urge all readers to give 
this Composite Plot greater thought and study. 
Although we are perfectly willing to grant that 
at the present time it is in its infancy, and that 
ten or twenty years hence we may look back with 
shame upon its present incompleteness, neverthe- 
less the economic principle underlying the Area 
Theory is absolutely sound, and if so, should not 
all of us unite in striving to apply it by devising 



INTEREST RATES FORECASTED 241 

a Composite Plot which will correctly interpret the 

said laws I 

It is Essentia] That We Should Solve 
Business Problems Correctly. 

Once the nations of the world wore dependent 
upon their armies. The nation which had a 
Caesar or a Wellington ruled supreme; later the 
statesmen ruled, and the nation which had a Pitt 
or a Bismarck determined the world's policy; but 
today the commercial interests of the nation dictate 
the world's policy. The eredit of our country or 
of any country during the next ten years will not 
depend on it- armies or its statesmen, but rather 
— after character — upon its hankers and mer- 
chants. Therefore, as it was onee the duty of a 
nation to see that its young men were trained along 
military and political lines, is it not our duty to 
that our young men are trained to diagnose 
correctly and. if possible, to forecast business con- 
ditions in order to guide safely our great indus- 
trial and financial enterprises, upon which the 
future of our nation is so dependent \ 



242 COMMERCIAL PAPER 

TABLE OF CONTENTS 

Preface ......... 5 

CHAPTER I. 

Lexdikg and Borrowing ...... 7 

Money is Unevenly Distributed .... 8 

Interest is Divided Between Borrowers and Lenders . 8 

Commercial Loans Carry Pure Interest Only . . 9 

Insurance of Commercial Loans Should be Possible . 10 

All Lenders Should Study Business Conditions . 12 

Loans are to be Classified ..... 12 

Classes I and II ....... 14 

The Place of Commercial Paper .... 14 

Collateral Loans . . . . . . .15 

A Margin Should be Guaranteed on Collateral Loans 1G 
Collateral Loans Form Our Best Test of the Money 

Market 17 

Weaker Collateral Loans Should be Especially Well 

Margined . . . . . . . .18 

The Best Collateral is Listed Collateral ... 19 
The Relation Between Banks and Their Customers 

^ Should be Very Close 20 

Banks Should Not Pay Interest on Borrowing Accounts 22 
Large Borrowers Need Resources Other Than Their 

Own Banks 22 

Many Large Borrowers Can Best Finance Themselves 

Through Well Secured Bonds .... 24 

Long Time Bonds Should be Especially Well Secured 25 

Debenture Bonds May Also be Satisfactory . . 2G 
Short Term Notes are Also Often Proper Mediums of 

Finance . . . . . . . . .27 

Short Term Railroad Debenture Notes May Also be 

Satisfactory . . . . . . .28 

Commercial Paper is a Medium of Finance for the 

Purchase of Merchandise Only .... 28 

We Have to Deal Here Chiefly With Commercial Paper 30 



TABLE OF CONTENTS 243 



CHAPTER II. 



Tin: Form of Commercial Papeb .... 31 
Refunding of ( ommercial Paper May or May Not be 

Permissible ........ 32 

It a Lender on Commercial Taper Wants His Money 

at Maturity He should Always Ge1 It . 
The Proceeds of Commercial Paper should go Into 

Merchandise Only . . . . . . .">i 

Commercial Paper Should Not he Used to Finance 

Fixed Assets 30 

A- a Rule Commercial Paper Cannot Carry Collateral : > »7 
No Commercial Paper should Run tor More Than a 

Year 40 

Most Commercial Paper should Mature in From 

\mety Day- t<> Six Months ..... 41 
Paper Used t" Finance Specialties should Run a Short 

Time Only 42 

Banks are Chiefly Responsible for the Form of Com- 
mercial Paper ...... 43 

Banks Should Demand Their Rights More Firmly . 4.'! 
Endorsements, When Available, Should be Given . 44 

Receivables are an Excellent Form of Commercial 

Paper ......... 4.") 

The Bank of England ...... 46 

[nterview with sir Felix Schuster, Baronet, Governor 

of the Union of London and Smith's Bank Ltd. . 4!> 
[nterview with the General Manager of the London 

Joint Stock Bank Ltd. 50 

[nterview with the Manager <>f the Union Discount 

Company of London Ltd. ..... 55 

land . . . . . . . .56 

[nterview 'with the General Manager of the Royal 

Bank of Scotland ....... 56 

[nterview with the General Manager of the Union 

Bank of v <-"i la ad Ltd. . . . . . . 57 

[nterview with tie- Genera] Manager of the c '< »m hh-i- 

<Til Bank of Scotland Ltd. . . .57 



244 COMMERCIAL PAPER 

France 59 

Interview with the Governor of the Bank of France 59 
Interview with the Administrator and with other 

Officials of the Credit Lyonnais . . . .61 

Interview with a Chief Official of the Credit Agricole 63 
Germany ........ 

Interview with the Officials of the Reichsbank . 
Interview with the Officials of the Deuche Bank 
Interview with Directors of the Dresdner Bank 
Interview with the Schultze-Delitzsch Co-operative 

Credit Societies ....... 

The Canadian System ..... 

We Seem Lax in Our Finance 

Borrowers Should Show Their Strength in the Form 

of Their Borrowing ..... 

We Should Use Receivables or Similar Paper 
Note Brokers Have an Important Part to Play 
Where Single Name Paper is Current Receivables Can 

not Exist in any Quantity .... 
The Position of Note Brokers is Likely to Change 
Cotton Bills are an Example of Our Problem 
Careful Finance Will Prevent Severe Panics 
Registration of Commercial Paper is a Help 
Registration is Not the Best Remedy 
Most of Our Commercial Paper is Good 
The Amount of Commercial Paper Outstanding is 

Enormous ....... 

Commercial Paper Proved of Great Assistance in the 

Last Panic ....... 



CHAPTER III. 



64 
64 
65 

66 

67 
67 
69 

70 
71 

72 

73 

75 
75 
76 
77 
78 
79 



80 
81 



The Selection of Commercial Paper ... 82 
Rules for the Buying of Commercial Paper Have to be 

Very Conservative ....... 82 

Where Possible Every Case Should be Considered on 

Its Individual Merits ...... 83 

If Possible Buy Receivables 84 



TABLE OF CONTENTS 245 

In Buying Other Than Loral Commercial Taper. Buy 
Only Through an Accredited Agent Such as a Note 
Broker in Good Standing ..... 84 

Make Sure That the Men Connected With the Firm 
or Corporation Issuing the Paper be Known to Have 
Absolute Integrity ...... 85 

The Firm or Company Issuing the Paper Offered 
SI old be Proved to Have Been Successful Over a 
Period oi Years Under 1;- Present Management ^7 

Buy Paper of Companies and Firms Dealing Only in 
Staple Commodities, for Which There is a St 
Demand and Which are Not Luxuries. If the Com- 
pany or Firm Deal in Other Than Such Commodities 
an Additionally Strong Showing should he Required SN 

Make Sure That the Company or Firm Issuing the 
Paper Offered S sonaB at statement at 1 
Two and a Quarter in Quick Assets Times Debt and 
no Mortgag t, or, it There is a Mortgage Debt. 

the Two and a Quarter in Quick Assets Should be 
in Addition to Other Than Quick Assets ^i at 1. 
- eral Times the M< _ _ Debt . . . 89 

Two and a Quarter of Quick Assets t«> One of Debt 

i- a Fair Patio ....... 90 

There are S Other Exceptions t<> This Kuie . 01 

a SI oform t<> the Rule . . 92 

When Credit is Working Freely This Ratio >h<>uld 
still be Required 93 

Liquid Assets — I ial . . . . 94 

A Bonded Debt is Sometimes Desirable er 95 

Make Sure That th< Si 'nmt of the ( ompany 
Wh<^ t . Paper i- Being Considered for Purcl 

- w Evidently an Over Large Amount <>r" 

rable, and Make Sure AN<> That the 

ii as Being I arried i- Appraised 

at a Fair Market Value 

The Merchai -'in Musi Represent 

a Fair Valuation ....... 



246 COMMERCIAL PAPER 

Make Sure That the Statements Shown be Audited 
or Come Through Persons Entirely Competent to 
Judge of Their Correctness ..... 98 
Make Sure That the Borrower Keeps One or More 
Bank Accounts in a Large City Near the Lender 
With Banks Which Will Vouch for the Goodness of 
the Company's Paper ...... 99 

If the Company in Question is in a Country Town, 
at Least Two of the Banks in its Home Town 
Should Vouch for it Besides One Reputable Bank in 
a Larger City. If the Company is in a Large City, 
at Least Two Banks in That City Should Report 
Favorably on It . . . . . . .99 

The Person Offering Paper Should do Most of the - 
Detail Work of Investigation, Presenting his Results 
With the Offering 100 

Make Sure That at Least Two Banks Competent to 
Judge of the Credit in Question and Others Than 
the Banks Which Have the Account of the Borrower 
Pass Favorably on the Credit of the Borrower . 101 

Where Trade References Can be Easily Obtained, at 
Least Four of These, Not Over Six Months Old, 
Should be Found to be Satisfactory . . . 101 

Make Sure That Insurance is Carried on all Merchan- 
dise Carried ........ 102 

Secure as Many Endorsements of Responsible Men 
Interested in the Company Borrowing as is Possible 103 

The Rate for the Paper Should be Satisfactory . . 103 

Large Borrowers Have to Pay a High Rate . . 104 

City Banks Do Not Get as High Rates as Country 
Banks 105 

Borrowers Should Not Expect Maximum or Minimum 
Rates at Their Own Banks ..... 106 

Low Rates Should Not Stop the Buying of Commercial 
Paper 107 



TABLE OF CONTENTS 247 

When Commercial Paper Rates are High There are 
Often Greater Bargains in Other Fields Than That 
of Commercial Paper ...... 107 

Discount should be Figured by Days . . . 108 

CHAPTER IV. 

Tin A\ llysis of a Financial Statement and Report 110 

A Financial Statement Should Appear in its Simplest 

Form 110 

The Usefulness of a Statement is in its Representa- 
tion of Contrast . . . ■ • • HI 
The Form of Statements Must Necessarily Differ . 112 
Liabilities should be Examined First . . .114 
It Should he Known How Much Cash the Capital Item 
Represents ........ 114 

The Money Equivalent of the Stock Item Should be 
Known . . . . . . . .116 

The Surplus Item Should Receive Very Careful Con- 
sideration ........ 110 

The Surplus Ttem is to be Analyzed . . . 117 

The Book Value of Fixed Assets Must be Carefully 

Studied 117 

The Purpose of any Depreciation Fund should Appear 110 
Statements for Several Years Back Should be Com- 
pared ......... 119 

Any Long Time Debt Item Ought to show the Matur- 
ity of the Debt 120 

Any Funded Debt Should Have a Large Margin of 

Safety 120 

Accounts are to l>e Kepi Distinct From 

other [tema 121 

Funded Debi should he Froic.-t.Mi by Fixed Assets . 121 
Earnings Should l><- Examined Carefully . . . L22 
The B tble [tem Should be Kepi Down . 123 

Great Emphasis Should !»<• Laid on the study of the 
Notes Payable [tem ...... 124 



248 COMMERCIAL PAPER 

It Should Appear Whether or not Notes Payable are 
Given for Merchandise ...... 125 

Notes Payable Form the Principal Item in Current 
Liabilities . . . . . . . .126 

The Bills Receivable Item Should be Small . . 126 

Quick Assets Should Protect Floating Debt . . 127 

Deposit Accounts May be Dangerous . . . . 128 

All Minor Liabilities Should Appear on a Statement 128 
Contingent Liabilities Should Also Appear . . 129 

It is Important to Know if a Company is a Partner- 
ship or a Corporation ...... 129 

Income and Expenditure Accounts Ought to be 
Analyzed ........ 131 

A Company Should be Making at Least Ten Percent 

Net 132 

We Have Examples of Properly Constituted State- 
ments ......... 132 

Net Earnings are Properly Earnings Applicable to 
Dividends . . . . . . .133 

A Proper Statement Will Contrast Earnings and Ex- 
penditures Over a Term of Years . . . 134 
In Such a Statement all Items Will be Followed by 
Explanatory Notes ....... 134 

A True Statement Will State All the Facts . . 135 

A Railroad Report is Necessarily Different from the 

Report of an Industrial Corporation . . .135 

The Most Important Factor in a Railroad Report is 
its Statement of Earnings ..... 136 

The Total Mileage of a Railroad Should Appear Clearly 137 
With the Mileage of Railroads in Mind a Comparison 
of the Roads Can be Made . . . .138 

No Item Should be Passed Over Carelessly . . 139 

A Proper Railroad Report Shows the Analysis of all 
Items ......... 140 

A Financial Report if Properly Framed Will Prove 
Conditions ........ 141 



TABLE OF CONTENTS 240 

CHAPTEB V. 



Banking 

Wealth has a Complex Meaning 

Wealth is the Foundation of Progress 

Wealth and Available Wealth are no! the -Same 

In Protecting Wealth Banks Assume a Most Important 

Duty 

The First Bankers Won 1 the Romans 
Money has Represented Wealth for a Long Period 
In the Middle Ages [nterest was Unearned 
Interest Was Then Regarded as Usury 
Banking Necessitates Individual Property Rights 
Capita] Must be Fairly Constant in Amount 
Capita] is Essentia] for Economic Advancement 
Wlum Trade Developed, Interest Became an Acknow 

edged Right ....... 

Banks Rule Interest Hates To-day 

Banks Rave Two Great Duties .... 

Banks Should be Allowed to Charge for Their Servie 
Money Credit Entails Convertibility Into Money 



Credit is the Most Important Factor in Our Finance 155 
Credit Appears in Many Forms .... 156 

Different Methods of Different Banks Are to be Studied 157 



The First Bank of the United states 

The First Bank of the United States Was Not 

Success . . . . . . # 

The Second Bank of the United States 

The Second Hank of the United states Was But Fair! 

Successful ....... 

Both Banks Encountered Unusual Difficulties 

The Currency Was the Chief Problem 

( Mir oking Was I fasound 

Our Early Banks Could do Almost Anything 

Our State Bank Note [ssues Were Fundamental! 

Unsound ........ 



143 

144 
145 
145 

146 
146 

147 
148 
149 
14!) 
150 
151 

151 

152 
153 
153 
154 



158 

159 
159 

160 
161 
161 

102 
163 

164 



mpt Ion "f Notes \\ as I be Problem . 164 



250. COMMERCIAL PAPER 

Early Banking Showed Many Abuses . . , . 165 

The Safety-Fund Banking Act Did Not Cover Suffi- 
cient Ground ....... 

Much of the Later State Banking Was Unsound 
The National Bank Act Solved Many Difficulties 
The National Bank Act Has Permitted Prosperity 
Savings Banks are Primarily for the Benefit of the 

People ........ 

Co-operative Banks are Similar Institutions 

Trust Companies and State Banks are to be Classed 

with National Banks ..... 
The Strength of Private Banking Houses is Dependent 

on Their Free Capital and Their Ability 
The Bank of England ..... 

The Bank of England Issues Notes Almost Wholly 

Against Gold ...... 

England Has an Inelastic Currency 

The Bank of England is a World Power 

English Banking Has Been Consolidated 

The Bank of France ...... 

The French View of Banking Differs From Much of 

Our Own ....... 

French Note Currency is Based Chiefly on Commercial 

Paper ........ 

The Note Issue is Dependent Absolutely on the Proper 

Commercial Demand ..... 

The French Credit System Has Worked Successfully 
France Has a Larger Power Over Gold Than Has the 

United States . . . 

The Reichsbank ....... 

The Reichsbank Has a Monopoly of Issue 

England, France and Germany Have Other Than 

Central Banks ...... 

Each of These Countries Has a Central Reserve 
Banks Must Have a Large Gold Reserve Available 
Banks are Public Servants, but They Must Make a 

Profit 186 



'ABLE OF CONTENTS 



251 



We Have No National Discount Market 

Bank Stock is Nbi a Desirable Investment for Women 

Bank- Perform Many Services . ... 

Banks Can [nVesI More Successfully Thau Tan Indi- 
viduals . . . . . . 

Banks Should Diversify Their [uyestments 
Banks Should Compete in Other Things Than [nteres! 
Exceptionally High Rate- on Deposits Are Not Usually 
Desirable ........ 

Banks Musi be Safe Depositories for Money 
Most Bank< Appreciate Their Foremost Duty 

CHAPTEB VI. 

Tin: Rediscounting <>i Commercial Paper 
Individuals or Corporations Investing in Commercial 

Taper do Not Usually Need to lvesell 
Banks Often do Xeed to Resell Commercial Paper 
England lias a Large Surplus Always Beady for the 

Rediscounting of Paper ...... 

We Have no Large Mini- Available for This Purpose . 
Prance and Germany Have Prepared Especially for 

the Rediscounting- of Commercial Paper 
With Foreign Banks Commercial Paper Forms Largely 

the First Reserve ..... 
There is Xeed for a Somewhat Similar System in the 

United States ...... 

Our Bank Reserves Musi be Bound Together 

An Asset Currency Has Many Dangers 

'1'ln- Rediscounting of Commercial Paper i- One of 

the Chief Duties <>t' a Central Reserve System 
Ther< ' of Liberalizing the Old National Bank 

. 

I .•- ;i re Much Too Seal 1 'Ted 

Does Nol Combine [nterests 
Much Money Now Goes [nto Call Loans 
Under the Old Faw There is no Ready Method of 
liscounting ........ 



1S7 

1SS 
IS!) 

189 
190 

191 

192 
193 
193 



19.-> 

195 
19G 

197 

198 

198 

200 

201 
202 
203 

•2<>:> 

20.") 
200 
206 
207 

207 



252 COMMERCIAL PAPER 

The Recent Law Permitting an Asset Currency Was 
But a Temporary Measure ..... 208 

It is an Innovation in This Country to Have Com- 
mercial Paper as a Basis for Currency . . . 209 
There are Views Opposing a Greatly Fluctuating 
Currency ........ 214 

The Aldrich Plan is New Practice for This Country . 217 
Mr. Morawetz has Presented Still Another View . 217 
Our Aim Must be to Mitigate and to Prevent Panics . 220 
All Financial Crises Show Many Similar Character- 
istics 220 

Recent Panics Have Been Like Earlier Ones . . 221 

Financial Crises May Arise From the Granting of Too 

Little or Too Much Credit 222 

We Should Introduce Innovations in Our Banking- 
Very Guardedly 223 

A Union of Reserves and an Asset Currency are 
Separate Problems ....... 224 

CHAPTER VII. 

How Interest Rates May be Forecasted . . 226 

The Intensity of Business Periods Should be Examined 227 

Business Intensity Alone Will Not Forecast Rates . 227 
Rates Depend on the Duration of the Intensity of 

Business . . . . . . . . . 228 

The Area Plan Best Represents Business Conditions . 228 

Mechanical Law is Applicable to Business Conditions 230 
The Area Plan Will Forecast Rates Better Than Any 

Other . . . 231 

Rates Follow Changes in the Business Areas . . 232 
Any Special Business Study, Such as the Study of 

Rates, Must be Based on the Area Plan . . . 232 

Such Studies Prove Definite Laws .... 233 
Business Areas, if Properly Drawn, Forecast Interest 

Rates Nicely . 233 

Study of the Composite Plot of Business Conditions 

is of Enormous Value ...... 234 



TABLE OF CONTENTS 



253 



Seasonal Variations Must be Allowed For . 

The New York Money Market lias Five Periods 

The Second Period Begins in February 

The Later Periods are Well Marked . 

Conditions in Different Parts of the Country Vary 

Bank Reports Should be Constantly Examined 

The ( omposite Plot Can be Bettered 

The Area Theory Must be the Basis for Much lines 

tigation ........ 

It is Essential That We Should Solve Businesi 

Problems Correct lv ...... 



235 
236 
236 

237 
238 
239 

240 

240 

241 



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IS CALLED TO OUK 

Instruction Courses 



ON 



Investments and Collateral 



EOR INVESTORS 

AND 

EMPLOYEES OF BOND HOUSES AND 
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mailed gratis upon request. 



Address EDUCATIONAL DEPARTMENT of 

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. Investment Conditions 

We are collecting, analyzing and distributing 
statistics on the 25 subjects mentioned in this 
book and are prepared to supply the results to 
Stock Exchange Firms, Bond Houses, Mercantile 
Houses, Manufacturers and Investors. 

By a study of the data which we supply, one 
can readily ascertain for himself whether we are in 
a Period of Prosperity, a Period of Depression, or 
are passing from one to the other; and what will 
be the next major change in trade, money rates 
and investment prices. 

The cost of this service is very small in com- 
parison with what it is costing firms to collect such 
data independently, and we believe that our figures 
are more accurate and more up to date than if 
collected by subscribers independently. Further 
particulars relative to this work will be sent gratis 
on application. Address 

Babson's Statistical Organization 

INCORPORATED 

WELLESLEY HILLS • MASSACHUSETTS 



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